Tax Due Diligence in M&A Transactions

The need for tax due diligence isn’t often top of mind for buyers focused on quality of earnings analyses and other non-tax reviews. Tax review can help to identify historical exposures or contingencies that could affect the financial model’s predicted return when buying an acquisition.

Tax due diligence is crucial, regardless of whether the company is C or S, an LLC, a partnership or an LLC or C corporation. These entities don’t pay entity-level income taxes on their income. Instead the net income is given to members, partners or S shareholders for personal ownership taxation. Due diligence should include a review of the possibility of a tax assessment of additional corporate income taxes by the IRS or other local or state tax authorities (and the associated interest and penalties), as a result of errors or incorrect positions uncovered on audit.

The need for a robust due diligence process has never been more vital. A greater amount of scrutiny by the IRS of foreign bank accounts that are not disclosed and other financial accounts, the expansion of state bases for sales tax nexus, changes in accounting procedures, and an increasing number of jurisdictions imposing unclaimed property statutes, are just a few examples of the many issues that need to be considered as part of any M&A transaction. Circular 223 can impose penalties on both the preparer who signed the agreement as well as the non-signing preparer, if they fail to comply with the IRS’s due diligence requirements.