Tax Due Diligence in M&A Transactions
Buyers are often more concerned with the quality of the analysis of earnings and other non-tax reviews. But completing a tax review could prevent substantial historical exposures and contingencies from becoming apparent that could impede the expected profit or return of an acquisition as forecasted in financial models.
Tax due diligence is vital regardless of whether a company is C or S, an LLC, a partnership or a C corporation. They generally don’t pay entity level tax on their net income; instead, net income is passed out to members, partners or S shareholders (or at higher levels in a tiered structure) for individual ownership taxation. Therefore, the tax due diligence effort needs to include reviewing whether there is a potential for a determination by the IRS or local or state tax authorities of additional tax liabilities for corporate income (and associated interest and penalties) as a consequence of mistakes or incorrect positions that are discovered in audits.
Due diligence is more critical than ever. The IRS is stepping up its scrutiny of accounts that aren’t disclosed in foreign banks and other financial institutions, the expansion of the state-based bases for the sales tax nexus as well as the increasing number of states that impose unclaimed property laws are some of the concerns that must be considered prior to completing any M&A deal. Based on the circumstances, failing to meet the IRS’ due diligence requirements could result in penalties assessed against both the signer and the nonsigning preparer under Circular 230.
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