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Tax Due Diligence in M&A Transactions

The necessity of tax due diligence isn’t always on the top of minds for buyers focused on how earnings analyses are conducted and other non-tax reviews. But conducting a tax review could prevent substantial historical exposures and contingencies from being discovered that could impact the expected profit or return of an acquisition that is forecast in financial models.

It doesn’t matter if the company is one of the C or S corporation, or is an LLC or a partnership, the need to conduct tax due diligence is important. These entities generally don’t pay entity level income taxes on their net income; instead the net income is distributed to members, partners or S shareholders (or at higher levels in a tiered structure) for taxation on ownership of individual. As a result, the tax due diligence focus should include examining whether there is a potential for a determination by the IRS or local or state tax authorities of an additional corporate income tax liabilities (and associated penalties and interest) due to errors or incorrect positions discovered during audits.

The need for a thorough due diligence process is more important than ever before. The IRS is stepping up its scrutiny of undisclosed accounts in foreign banks and other financial institutions, the expanding of the state-based bases for the nexus between sales and tax, and the growing number of states that impose unclaimed property laws are just a few of the issues that must be considered when completing any M&A deal. Depending on the circumstances, failure to meet the IRS due diligence requirements could result in penalty assessments against both the signer and the nonsigning preparer under Circular 230.

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April 23, 2024

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