Private equity groups should be aware of potential risks stemming from recent shifts in the state indirect tax landscape, especially as it relates to nexus rules and tax obligations for software companies. Governments are rolling out new tax frameworks aimed at digital goods and services. Meanwhile, U.S. states are and stepping up enforcement efforts. These developments have created a more complex and aggressive tax environment for technology-driven businesses.
How Can Middle-Market Companies Navigate These State Tax Changes?
Companies need to be vigilant and proactive on the state indirect tax front. Every state with a sales tax regime (45 states plus DC) has fully adopted and are actively enforcing economic nexus laws. These new laws can require companies to collect and remit sales tax on transactions occurring in that state even where the company has no physical presence in the state. The new provisions were enacted in the wake the U.S. Supreme Court’s landmark decision in the 2018 Wayfair case, which expanded the states’ ability to tax out-of-state companies, allowing them to impose taxes on entities and transactions that were out of reach pre-Wayfair. State and local taxing authorities are now leveraging these laws aggressively and asserting taxes on software, SaaS, digital goods, and platform-based services with increasing frequency and confidence.
In addition to their expanded authority to tax out-of-state companies, many state taxing authorities have widen their interpretations of what qualifies as a taxable product or service, and software and SaaS providers have emerged as a prime target. This now includes not only B2B SaaS, but also streaming platforms, data hosting, cloud infrastructure, and AI-enabled services. Jurisdictions are using existing statutes in more expansive ways—e.g., classifying digital services under traditional tax categories or redefining them altogether.
In addition to aggressive enforcement, many state and local legislative bodies have enacted new laws that further extend their taxing reach and scope. These changes can allow for the taxation of previously untaxed entities and products, such as digital goods and their equivalents. Several states have redefined taxable categories to explicitly include cloud-based platforms and software bundles that incorporate automation or advanced analytics. As business models evolve, so does the scope of what’s considered taxable.
This trend is unlikely to change in the immediate future. With the previous “physical presence-only” limitations having been eliminated via the Wayfair decision, these jurisdictions are unsurprisingly eager to collect all the taxes they can, and these shifts present them with a “target-rich” environment.
As a result of these changes, the focus should move from the initial question of “if” private equity investees will be subject to these taxes, to the assumption that they likely are until proven otherwise. As such, the issue becomes “getting it right” on the front end. For example, investors should be asking if the correct amount of tax has been paid by the appropriate taxpayer to the correct jurisdiction. Additionally, remote and offshore workforces bring new challenges when it comes to tax nexus, permanent establishment, and payroll tax obligations. This is particularly true for tech companies that rely on widely dispersed teams.
With the new-found ability of states to assert existing taxes and the enactment of new taxes, coupled with the evolution of more complex business structures, these questions don’t get any easier. And they aren’t going away anytime soon. Accordingly, here are a few questions investors and owners of tech companies should ask themselves and their potential portfolio companies:
Three Questions Investors Should Ask About State Taxes
1. What are your companies selling, and are they subject to tax?
Different jurisdictions have different rules. What is taxable in one jurisdiction may not be taxable in another.
- Are AI-enabled or analytics-enhanced products being classified differently?
- Has bundling of software, services, and support triggered new tax treatments?
Technology companies often sell SaaS, licenses, data analytics, or bundled offerings. Each of these is subject to varying regulations depending on the state. Some states see SaaS as a taxable service or product, while others view it as non-taxable. Understanding how each component is classified by the jurisdictions in which the company is doing business is critical to determining exposure.
2. Where are your companies engaged in business?
Does this activity create a tax collection obligation and filing requirements? Jurisdictions have different filing requirements and thresholds.
- How extensive are the company’s activities or sales in a given jurisdiction?
- Are remote employees or third-party contractors in other states or countries creating nexus?
Even if a business doesn’t have an in-state physical location, economic nexus can be triggered by thresholds such as having $100,000 in sales or 200+ transactions per year into a state. Activities such as digital transactions, remote staff, or temporary business activities can create filing and remittance obligations across multiple states.
3. If a company is subject to sales tax in a certain jurisdiction on a particular item, are there any exemptions that may apply?
If so, has the exemption been properly documented and secured? If a transaction is not exempt, has the tax been paid to the appropriate jurisdiction? For example, transactions often have multiple “touches” with services occurring and /or parties being located in two, three or even more jurisdictions. If you have to pay tax, make sure you are paying it in the right places.
- Exemption documentation and resale certificates should be up-to-date in the event of an audit
- These certificates should be reviewed regularly, especially as state laws evolve.
Additionally some states provide credits or exemptions for investments in R&D, software development, or digital infrastructure. However, you’ll need to keep strict and accurate documentation for these. Having inadequate or expired certificates can lead to expensive assessments of back taxes or missed opportunities for tax relief.
In this post-Wayfair environment it takes more than just checking the right boxes to understand your state tax obligations. It’s all about understanding what you are selling, where your business operates, and how exemptions come into play. If you are an investor looking at potential acquisitions or assessing portfolio risk, it’s crucial to ask the right questions about taxability, nexus, and documentation.
Adding deeper analysis around revenue sourcing and pass-through considerations can better guard against hidden risks and achieve a more accurate valuation. With tax complexity rising, front-end diligence is sensible and strategic.
Address State Tax Liabilities Before They Disrupt the Deal
By knowing these taxes are out there and are being asserted more broadly and aggressively than ever, you can minimize the tax uncertainty and disruption inherent in any new acquisition or structure. Middle-market firms are also embracing tax automation and AI-driven compliance tools to simplify reporting, manage risk, and withstand regulatory scrutiny.
Stay close to your tax advisors on any new deal or acquisition. It is far better for them to alert you to the existence of these taxes and potential liabilities so that you know what you are walking into from the beginning and can take steps to eliminate or reduce any unpleasant tax surprises.
Please contact the LBMC SALT Group or your LBMC Tax Advisor if you have questions or need assistance.
Content provided by LBMC State and Local Tax professionals, Leigh Ann Vernich and Jay Hancock.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.