The necessity of tax due diligence is not URL often on the radar of buyers who are concerned about the quality of earnings analysis and other non-tax reviews. But doing the tax review could prevent substantial historical risks and contingencies becoming apparent that could impede the expected return or profit of an acquisition as forecasted in financial models.
It doesn’t matter if the company is a C or S corporation, or is a partnership or an LLC it is essential to conduct tax due diligence is important. The majority of these entities do not have to pay entity level income taxes on their net income; instead, net income is passed out to partners or members or S shareholders (or at higher levels in a tiered structure) to be taxed on individual ownership. In this way, the tax due diligence process needs to include reviewing whether there is a potential for assessment by the IRS or local or state tax authorities of additional corporate income tax liabilities (and associated penalties and interest) 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 vital. More scrutiny by the IRS of undisclosed foreign bank and other financial accounts, the growth of state bases for sales tax nexus, changes in accounting methods, and an increasing number of states imposing unclaimed property statutes, are just a few of the many issues that must be taken into consideration in any M&A transaction. Circular 230 may impose penalties on both the preparer who signed the agreement and the non-signing preparer if they fail to comply with the IRS’s due diligence requirements.
