Buyers are often more concerned with the quality of earnings analysis as well as other non-tax reviews. However, completing the tax review can prevent significant historical risks and contingencies from emerging that could derail the anticipated return or profit of an acquisition as forecasted in financial models.
If a company is an C or S corporation, or is a partnership or an LLC, the necessity of conducting tax due diligence is important. These entities do not have to pay tax on income at the level of an entity for income. Instead the net income is distributed to members, partners or S shareholders for the purpose of individual ownership taxation. As a result, the tax due diligence effort needs to include reviewing whether there is the potential for assessment by the IRS or state or local tax authorities of additional corporate income tax liability (and associated interest and penalties) as a consequence of mistakes or inaccurate positions found during an audit.
Due diligence is more crucial than ever. The IRS’ increased scrutiny of accounts that are not disclosed in foreign banks and financial institutions, the expansion of the state base for the sales tax nexus as well as the growing number of jurisdictions that impose unclaimed property laws are some of the issues that must be taken into consideration when completing an M&A deal. Circular 230 can impose penalties for both the party signing the agreement as well as the non-signing preparedr if they do not comply with the IRS’s due diligence requirements.
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