Tax Due Diligence in M&A Transactions
The necessity of tax due diligence isn’t often on the radar of buyers who are concerned about the how earnings analyses are conducted and other non-tax reviews. Tax reviews can help discover historical exposures or contingencies that could affect the financial model’s predicted return for an acquisition.
Tax due diligence is crucial, regardless of whether a company is C or S, an LLC, a partnership or a C corporation. These entities don’t pay entity-level income taxes on their income. Instead the net income is divided among members, partners or S shareholders for individual ownership taxation. Therefore, the tax due diligence approach needs to include reviewing whether there is a potential for assessment by the IRS or local or state tax authorities of an additional tax liability for corporate income (and associated penalties and interest) due to mistakes or inaccuracy of positions discovered during an audit.
The need for a thorough due diligence process has never been more vital. The IRS’ increased scrutiny of accounts that aren’t disclosed in foreign banks and financial institutions, the expansion of the state bases for the nexus between sales and tax, and the growing number of states that impose unclaimed property laws are some of the concerns that must be taken into consideration when completing an M&A deal. Circular 230 can impose penalties on both the person who signed the agreement and the non-signing preparation company if they do not comply with the IRS’s due diligence requirements.