The necessity of tax due diligence isn’t often top of mind for buyers focused on quality of earnings analysis and other non-tax reviews. Tax reviews can help uncover historical risks or contingencies that could affect the financial model’s predicted return for an acquisition.
Tax due diligence is essential, regardless of whether a business is C or S, an LLC, a partnership or a C corporation. These types of entities do not pay income tax at the entity level on their income. Instead the net earnings are distributed to partners, members or S shareholders to pay individual ownership taxation. Therefore, the tax due diligence approach must include a review of whether there is the potential for assessment by the IRS or local or state tax authorities of additional corporate income tax liabilities (and associated penalties and interest) due to mistakes or inaccurate positions found in audits.
Due diligence is more important than ever. The IRS is stepping up its scrutiny of accounts that are not disclosed in foreign banks and other financial institutions, the expansion of the state bases for the nexus between sales and tax, and the growing number of jurisdictions that impose unclaimed property laws are just a few of the issues that must be taken into consideration when completing an M&A deal. In certain circumstances, not meeting the IRS’ due diligence requirements can result the transformative role of VDRs in energy sector mergers in penalty assessments against both the signer and non-signing preparer under Circular 230.
