State taxes – Are you covered? Considerations for private equity fund managers
Over the past two years, due to tax reform and judicial action, state tax rules have become more complicated and burdensome than ever. The Tax Cuts and Jobs Act of 2017 involved sweeping federal income tax changes, which consequently led to state income tax changes that vary widely across the country. In June 2018, the U.S. Supreme Court, in South Dakota v. Wayfair Inc., overturned decades of precedent, significantly changing sales tax nexus rules. Combined, these changes create a historic and challenging time for state tax planning and compliance, increasing both tax risk and tax compliance costs.
Due to all of these major changes, it is crucial for investment professionals to understand current state tax rules and how those rules apply to their businesses and potential investments. Private equity funds deal with the application of these state tax rules during the due diligence process, prior to a purchase or sale, the effects of which can impact the deal significantly. In the case of acquisitions, these state tax rules can impact the acquired business prospectively until it is sold and, potentially, beyond.
Portfolio companies are generally growing businesses introducing new products and services into new jurisdictions. This growth presents an even greater need for awareness and diligence. As new product lines or revenue streams are introduced, businesses unaware of the various state tax rules in their customers’ jurisdictions face increased risks and costs. Businesses aware of these rules will pay increased compliance and related costs or face increased risks. All portfolio companies confront increased state tax audits, particularly due to enforcement of these new nexus rules, which currently are the biggest state tax risk facing most multistate businesses.
Investors, especially those owning interests in pass-through entities, are directly affected by the activities of the businesses they own. A state tax assessment imposed on such a business may create an additional liability, and state tax filing requirement(s), for each investor. Identifying when returns are required and properly applying state revenue sourcing rules is, therefore, essential. In addition, many investors seek to minimize the volume of state tax filings by utilizing entity-level composite returns, which normally subject such income to the highest marginal state rate in that jurisdiction.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
Strategic Tax Issues for Capital Markets