The necessity of tax due diligence is not often on the radar of buyers focused on quality of earnings analyses as well as other non-tax reviews. Tax review can help to identify past exposures or contingencies that could affect the financial model’s projected return on an acquisition.
If a company is one of the C or S corporation, or is a partnership or an LLC, the necessity of conducting tax due diligence is important. These entities generally do not 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. Due diligence should consist of a review of the possibility of a determination of additional corporate income taxes by the IRS or other local or state tax authorities (and the associated penalties and interest), as a result of errors or incorrect positions uncovered on audit.
Due diligence is more crucial than ever. Increased scrutiny by the IRS of unreported foreign bank and other financial accounts, the expansion of state-based bases for sales tax nexus, changes in accounting methods, as well as an increasing number of states imposing unclaimed property statutes, are just some of the numerous issues that must be considered in any M&A transaction. Depending on the circumstances not meeting the IRS due diligence requirements can result in penalties assessed against both the signer and non-signing preparer under Circular 230.
