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Tax Due Diligence in M&A Transactions

The necessity of tax due diligence is not always top of mind for buyers who are concerned about the quality of earnings analysis and other non-tax reviews. Tax reviews can help discover historical exposures or contingencies that could impact the financial model’s predicted return for an acquisition.

Tax due diligence is crucial regardless of whether a company is C or S or a partnership, an LLC or a C corporation. They generally do not pay entity-level income taxes on their net income; instead, net income is passed to members, partners or S shareholders (or at higher levels in a tiered structure) for taxation on ownership of individual. Therefore, the tax due diligence effort should include examining whether there is a possibility for a determination by the IRS or state or local tax authorities of an additional tax liability for corporate income (and associated interest and penalties) as a consequence of errors or incorrect positions discovered during an audit.

Due diligence is more important than ever. The IRS is now under greater scrutiny for undisclosed accounts in foreign banks and other financial institutions, the expansion of the state base for the sales tax nexus, and the growing number of states that impose unclaimed property laws are just some of the concerns that must be considered prior to completing any M&A deal. Depending on the circumstances not meeting the IRS due diligence requirements could result in penalties assessed against both the signer and non-signing preparer under Circular 230.

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