Tax Due Diligence in M&A Transactions

Buyers are usually more concerned with the quality of earnings analysis and other non-tax reviews. But doing the tax review could prevent substantial historical risks and contingencies from emerging that could derail the expected return or profit of an acquisition, as predicted in financial models.

Tax due diligence is essential, regardless of whether the company is C or S or an LLC, a partnership or a C corporation. These entities do not pay entity-level income taxes on their income. Instead, the net income is distributed to members, partners or S shareholders for the purpose of individual ownership taxation. Due diligence should include a review of the possibility of a determination of additional corporate income taxes by the IRS and state or local tax authorities (and the associated interest and penalties) due to of erroneous or inaccurate positions uncovered on audits.

Due diligence is more critical than ever. The IRS has increased its scrutiny of accounts that are not disclosed to foreign banks and financial institutions, the expansion of the state bases for the sales tax nexus, and the increasing number of states that impose unclaimed property laws are a few of the factors that need to be considered prior to completing any M&A deal. Circular 230 can impose penalties on both the person who signed the agreement as well as the non-signing preparation company if they fail to meet the IRS’s due diligence requirements.

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