The necessity of tax due diligence isn’t often on the radar of buyers who are focusing on the quality of earnings analyses as well as other non-tax reviews. Tax review can help to identify historical exposures or contingencies that could impact the financial model’s predicted return on an acquisition.
No matter if a business is one of the C or S corporation, or is an LLC or a 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 the net income is distributed to members, partners or S shareholders (or at higher levels in a tiered structure) for individual ownership taxation. In this way, the tax due diligence process must include examining whether there is a possibility for assessment by the IRS or state or local tax authorities of additional tax liability for corporate income (and associated interest and penalties) due to mistakes or inaccurate positions found in audits.
Due diligence is more important than ever. The IRS’ increased scrutiny of undisclosed accounts in foreign banks and other financial institutions, the expansion of the state bases for the sales tax nexus and the increasing number of states that impose unclaimed property laws are just a few of the factors that need to be taken into consideration when completing an M&A deal. Based on the circumstances, not meeting the IRS due diligence requirements could result in penalties being assessed against both the signer as well as the non-signing preparer under tax preparation due diligence Circular 230.