Tax Due Diligence in M&A Transactions

The need for tax due diligence is not often top of mind for buyers focused on quality of earnings analysis and other non-tax reviews. Tax reviews can help identify historical exposures or contingencies that could impact the financial model’s predicted return on an acquisition.

Tax due diligence is crucial, regardless of whether a company is C or S or an LLC, a partnership or an LLC or C corporation. The majority of these entities do not pay entity level income taxes on their net income; instead net income is distributed to members, partners or S shareholders (or at higher levels in a tiered structure) for taxation of individual ownership. Due diligence should consist of a review of the possibility of an assessment of additional corporate income taxes by the IRS, local or state tax authorities (and the penalties and interest that go with it) due to of mistakes or incorrect positions found on audits.

The need for a thorough due diligence process has never been more vital. The IRS has increased its scrutiny of accounts that aren’t disclosed in foreign banks and other financial institutions, the expanding of the state bases for the sales tax nexus and the growing number of jurisdictions that have unclaimed property laws are just some of the concerns that must be taken into consideration when completing an why secure dataroom is your way to success M&A deal. Depending on the circumstances failing to meet the IRS due diligence requirements can result in penalties assessments against both the signer and non-signing preparer under Circular 230.