Fall 2025

There are various forms of mergers and acquisitions (e.g., stock deal vs. asset deal) and several nontax considerations during diligence (e.g., legal, human resources, technology, etc.), but this column will focus on state and local tax considerations during merger and acquisition (M&A) diligence. Specially, we will highlight some of the more complex issues that have arisen in recent years due to how companies now transact business and the state law changes that have occurred to keep pace.

Taxability Issues – Sales Tax

Sales tax issues are one of the more common tax diligence areas that may materially impact a M&A transaction; therefore, we recommend the buyer be knowledgeable of state laws and regulations regarding taxability, exemptions, and industry-specific issues.

For example, over the past decade there has been a significant increase in the number of companies whose revenue streams are earned through technology platforms, such as software-as-a-service (SaaS) and data-as-a-service (DaaS). Historically, sales tax laws and guidance addressed tangible personal property and services, and software had been sold as a tangible product. However, tech products have moved to electronic delivery and web-based access. Previously, states did not impose sales tax on the electronically delivered sale of software, but that is changing. While many states still have unclear or no guidance commenting on the taxability of SaaS, they are continuing to update or create guidance every year.

Even in states that do tax remotely accessed, web-based software, there can be confusion regarding the proper taxability. A primary issue is who has the interactive functionality of the software. Often, when customers have the interactive functionality, SaaS is considered a taxable software license in the states that impose sales tax on SaaS. However, when the SaaS is used solely as a medium for a customer to transmit data to a service provider (such as a lawyer or accountant), the software can be considered a nontaxable professional service. Additionally, whether the software is custom made or “canned” (off-the-shelf) should be considered. The distinction can be complex, and the taxability could be dependent on the level of modifications needed. Exemptions may apply in the case the software offering is considered taxable, including exempt-customer status and business-use exemptions. Pennsylvania generally imposes a sales tax on SaaS and other digital goods.¹

While the sale of assets during M&A is often subject to sales tax, some states may consider the sale of substantially all of a company’s assets to be an occasional sale outside of the normal course of the seller’s business and will not subject the transaction to sales tax.² Furthermore, most states have bulk sale notification laws, in which the buyer obtains bulk sale certificates from the seller, which protects them from any related successor liabilities.³

Nexus Issues

Physical presence used to be the standard upon which nexus was created. Since the U.S. Supreme Court decision in South Dakota v. Wayfair Inc. in 2018, every state imposing a sales tax has enacted economic nexus provisions under which filings are required when sales exceed a standard threshold in a 12-month period (typically $100,000). Before this case, only a handful of states had economic nexus provisions for income tax purposes; since this case, there are now 16 states that have enacted such provisions. Pennsylvania is one of them, with nexus thresholds of $100,000 for sales tax and $500,000 for income tax. Due to these changes, nexus and unmet filings is a common diligence finding.

Another recent change in the nexus landscape occurred in 2021 when the Multistate Tax Commission (MTC) updated its statement on Public Law 86-272, which generally prohibits a state from imposing a tax based on net income if the only activity of a taxpayer therein is solicitation of sales of tangible personal property with orders being approved and shipped from outside the state. Certain ancillary activities are also protected.

With its updated statement, the MTC espoused that businesses that place internet cookies onto computers or businesses engaging with marketplace facilitators who hold the business’s inventory in outside states exceeds Public Law 86-272 protections.⁴ Three states (California, New Jersey, and New York) have affirmatively indicated adoption of such positions, and it is likely others will follow suit. Of note, Public Law 86-272 protection trumps factor presence and brightline economic nexus sales thresholds. Both online retailers and other businesses with websites that allow for other functionalities (such as job application functionality and interactive customer service, etc.) should consider the applicability of this MTC standard in making nexus and filing determinations.

Apportionment Issues

An area of significant change over the past decade is how the sale of nontangible personal property should be sourced for the purpose of determining the sales factor for income/franchise tax purposes. Historically, most states required such sales to be sourced based on where the taxpayer incurred the costs to generate such revenue (i.e., “cost of performance” sourcing). Today, a majority of states require market-based sourcing (i.e., where the benefit is received by the customer), including Pennsylvania.⁵

While several states have published hierarchical ordering rules that lay out how to determine where the benefit is received for a customer, several do not. Even among those that do, the actual rules can vary from state-to-state. Due to these differences, it is possible that a sale could be sourced to more than one state or even to no state at all. It is a common diligence finding that a company used flawed apportionment methodologies. Errors related to sales sourcing provisions can also lead to misapplication of economic nexus provisions.

Conclusion

M&A transactions can be complex and detailed. Companies should be aware of the considerations outlined above, especially smaller, midsized, and early-stage companies for which the primary focus tends to be on growing the business relative to tax compliance.

There is much more, of course. The focus of this column was M&A considerations for sales and income/franchise taxes. Companies should also be aware of issues related to real property tax, personal property tax, payroll taxes, unclaimed property, and successor liabilities. These tax diligence issues should be considerations during the normal course of business operations to mitigate potential exposure during an M&A transaction.

If an issue is identified during tax diligence it could change the economics of the deal, including the sales price of the transaction. 

² Note that assets sales/deemed asset sales should also be considered for income/franchise tax, as states have different sourcing rules for apportionment (e.g., commercial domicile, where assets are located, etc.) and could create an unintended result.

³ 72 Pa. Stat. Section 1403.

⁴ Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272, at 8 (Aug. 4, 2021).

⁵ 72 Pa. Stat. Section 7401(3)2.(a)(17). Pennsylvania treats sales of intangible assets differently for sourcing purposes, for more information, see Corporation Tax Bulletin 2024-01, “Sourcing Sales Other Than Tangible Personal Property and Services.”

There are various forms of mergers and acquisitions (e.g., stock deal vs. asset deal) and several nontax considerations during diligence (e.g., legal, human resources, technology, etc.), but this column will focus on state and local tax considerations during merger and acquisition (M&A) diligence. Specially, we will highlight some of the more complex issues that have arisen in recent years due to how companies now transact business and the state law changes that have occurred to keep pace.

Taxability Issues – Sales Tax

Sales tax issues are one of the more common tax diligence areas that may materially impact a M&A transaction; therefore, we recommend the buyer be knowledgeable of state laws and regulations regarding taxability, exemptions, and industry-specific issues.

For example, over the past decade there has been a significant increase in the number of companies whose revenue streams are earned through technology platforms, such as software-as-a-service (SaaS) and data-as-a-service (DaaS). Historically, sales tax laws and guidance addressed tangible personal property and services, and software had been sold as a tangible product. However, tech products have moved to electronic delivery and web-based access. Previously, states did not impose sales tax on the electronically delivered sale of software, but that is changing. While many states still have unclear or no guidance commenting on the taxability of SaaS, they are continuing to update or create guidance every year.

Even in states that do tax remotely accessed, web-based software, there can be confusion regarding the proper taxability. A primary issue is who has the interactive functionality of the software. Often, when customers have the interactive functionality, SaaS is considered a taxable software license in the states that impose sales tax on SaaS. However, when the SaaS is used solely as a medium for a customer to transmit data to a service provider (such as a lawyer or accountant), the software can be considered a nontaxable professional service. Additionally, whether the software is custom made or “canned” (off-the-shelf) should be considered. The distinction can be complex, and the taxability could be dependent on the level of modifications needed. Exemptions may apply in the case the software offering is considered taxable, including exempt-customer status and business-use exemptions. Pennsylvania generally imposes a sales tax on SaaS and other digital goods.¹

While the sale of assets during M&A is often subject to sales tax, some states may consider the sale of substantially all of a company’s assets to be an occasional sale outside of the normal course of the seller’s business and will not subject the transaction to sales tax.² Furthermore, most states have bulk sale notification laws, in which the buyer obtains bulk sale certificates from the seller, which protects them from any related successor liabilities.³

Nexus Issues

Physical presence used to be the standard upon which nexus was created. Since the U.S. Supreme Court decision in South Dakota v. Wayfair Inc. in 2018, every state imposing a sales tax has enacted economic nexus provisions under which filings are required when sales exceed a standard threshold in a 12-month period (typically $100,000). Before this case, only a handful of states had economic nexus provisions for income tax purposes; since this case, there are now 16 states that have enacted such provisions. Pennsylvania is one of them, with nexus thresholds of $100,000 for sales tax and $500,000 for income tax. Due to these changes, nexus and unmet filings is a common diligence finding.

Another recent change in the nexus landscape occurred in 2021 when the Multistate Tax Commission (MTC) updated its statement on Public Law 86-272, which generally prohibits a state from imposing a tax based on net income if the only activity of a taxpayer therein is solicitation of sales of tangible personal property with orders being approved and shipped from outside the state. Certain ancillary activities are also protected.

With its updated statement, the MTC espoused that businesses that place internet cookies onto computers or businesses engaging with marketplace facilitators who hold the business’s inventory in outside states exceeds Public Law 86-272 protections.⁴ Three states (California, New Jersey, and New York) have affirmatively indicated adoption of such positions, and it is likely others will follow suit. Of note, Public Law 86-272 protection trumps factor presence and brightline economic nexus sales thresholds. Both online retailers and other businesses with websites that allow for other functionalities (such as job application functionality and interactive customer service, etc.) should consider the applicability of this MTC standard in making nexus and filing determinations.

Apportionment Issues

An area of significant change over the past decade is how the sale of nontangible personal property should be sourced for the purpose of determining the sales factor for income/franchise tax purposes. Historically, most states required such sales to be sourced based on where the taxpayer incurred the costs to generate such revenue (i.e., “cost of performance” sourcing). Today, a majority of states require market-based sourcing (i.e., where the benefit is received by the customer), including Pennsylvania.⁵

While several states have published hierarchical ordering rules that lay out how to determine where the benefit is received for a customer, several do not. Even among those that do, the actual rules can vary from state-to-state. Due to these differences, it is possible that a sale could be sourced to more than one state or even to no state at all. It is a common diligence finding that a company used flawed apportionment methodologies. Errors related to sales sourcing provisions can also lead to misapplication of economic nexus provisions.

Conclusion

M&A transactions can be complex and detailed. Companies should be aware of the considerations outlined above, especially smaller, midsized, and early-stage companies for which the primary focus tends to be on growing the business relative to tax compliance.

There is much more, of course. The focus of this column was M&A considerations for sales and income/franchise taxes. Companies should also be aware of issues related to real property tax, personal property tax, payroll taxes, unclaimed property, and successor liabilities. These tax diligence issues should be considerations during the normal course of business operations to mitigate potential exposure during an M&A transaction.

If an issue is identified during tax diligence it could change the economics of the deal, including the sales price of the transaction. 

² Note that assets sales/deemed asset sales should also be considered for income/franchise tax, as states have different sourcing rules for apportionment (e.g., commercial domicile, where assets are located, etc.) and could create an unintended result.

³ 72 Pa. Stat. Section 1403.

⁴ Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272, at 8 (Aug. 4, 2021).

⁵ 72 Pa. Stat. Section 7401(3)2.(a)(17). Pennsylvania treats sales of intangible assets differently for sourcing purposes, for more information, see Corporation Tax Bulletin 2024-01, “Sourcing Sales Other Than Tangible Personal Property and Services.”