Tax Due Diligence in M&A Transactions

The necessity of tax due diligence is not often top of mind for buyers who are focused on the how earnings analyses are conducted and other non-tax reviews. However, completing the tax review can stop significant historical exposures and contingencies from becoming apparent that could impede the anticipated profit or return of an acquisition as forecasted in financial models.

No matter if a business is an C or S corporation, or a partnership or an LLC, the need to conduct tax due diligence is essential. These entities do not pay income tax at the entity level on example of tax preparation due diligence their income. Instead the net earnings are divided among members, partners or S shareholders to pay individual ownership taxation. Therefore, the tax due diligence process needs to include reviewing whether there is the potential for assessment by the IRS or state or local 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.

The need for a robust due diligence process has never been more crucial. The increased scrutiny by the IRS of unidentified foreign bank and other financial accounts, the expansion of state bases for sales tax nexus, changes in accounting methods, and an increasing number jurisdictions imposing unclaimed property statutes, are just some of the many issues that need to be considered as part of any M&A transaction. In certain circumstances, failure to meet the IRS’ due diligence requirements can result in penalty assessments against both the signer and the non-signing preparer under Circular 230.