Buyers are typically more concerned about the quality of earnings analysis as well as other non-tax reviews. But doing the tax review can help prevent significant historical risks and contingencies being discovered that could impact the expected profit or return of an acquisition forecasted in financial models.
Tax due diligence is crucial regardless of whether a company is C or S, an LLC, a partnership or an LLC or C corporation. They generally do not pay entity-level income taxes on their net income; instead net income is distributed out to partners or members or S shareholders (or at higher levels in a tiered structure) to be taxed on individual ownership. In this way, the tax due diligence approach needs to include reviewing whether there is the potential for assessment by the IRS or state or local tax authorities of an additional tax liabilities for corporate income (and associated interest and penalties) as a consequence of mistakes or incorrect positions that are discovered during an audit.
The need for a thorough due diligence process has never been more crucial. The IRS’ increased scrutiny of accounts that are not disclosed in foreign banks and financial institutions, the expanding of the state bases for the sales tax nexus and the growing amount of jurisdictions that enforce unclaimed property laws are some of the concerns that must be considered prior to completing any M&A deal. Depending on the circumstances, failure to meet the IRS’ due diligence requirements could result in penalties assessments against both the signer as well as the non-signing preparer under Circular 230.