The necessity of tax due diligence isn’t always top of mind for buyers who are concerned about the how earnings analyses are conducted and other non-tax reviews. However, completing the tax review can prevent significant past exposures and contingencies from emerging that could derail the anticipated return or profit of an acquisition that is forecast in financial models.
It doesn’t matter if the company is an C or S corporation, or is an LLC or partnership, the need to conduct tax due diligence is essential. These types of entities typically don’t pay entity level tax on their net income; instead net income is distributed out to members or partners or S shareholders (or at higher levels in a tiered structure) to be taxed on individual ownership. Due diligence should include a study of the possibility of a determination of additional corporate income taxes by the IRS, local or state tax authorities (and the penalty and interest associated with it) due to of incorrect or erroneous positions discovered in audits.
Due diligence is more essential than ever. The IRS’ increased scrutiny of accounts that are not disclosed to foreign banks and other financial institutions, the expanding of the state bases for the sales tax nexus and the growing number of jurisdictions that impose unclaimed property laws are just some of the factors that need to be considered when completing any M&A deal. Circular 23 can impose fines on both the preparer who signed achieving success with secure digital rooms the agreement as well as the non-signing preparer, if they fail to meet the IRS’s due diligence requirements.
