Tax due diligence is a crucial aspect of M&A that is often left unnoticed. Because the IRS cannot effectively conduct an audit of all tax-paying company in the United States, mistakes or mistakes made during the M&A process could lead to onerous penalties. A thorough and well-organized process can aid in avoiding these penalties.
In general tax due diligence is the review of previously filed tax returns as well as current and historical informational filings. The scope of the audit varies according to the type of transaction. Entity acquisitions, for example are more likely to expose a company than asset purchases, as target companies that are tax deductible may be jointly and severally liable for the tax liabilities of the participating corporations. Other considerations include whether a taxable entity has been included on the consolidated federal tax returns and the amount of documentation related to transfer pricing for intercompany transactions.
Reviewing tax returns from due diligence in tax preparations prior years will also show whether the company is in compliance with applicable regulatory requirements, as well as a variety of warning signs that may indicate tax abuse. These red flags may include, but not be specific to:
Interviews with top management personnel are the final step in tax due diligence. These interviews are designed to answer any questions that the buyer might have and to resolve any issues that may affect the transaction. This is particularly important when dealing with acquisitions that have complex structures or unclear tax positions.
