Tax Due Diligence in M&A Transactions

Tax due diligence is an essential aspect of M&A that is often overlooked. Because the IRS can’t effectively conduct a tax audit of every company in the United States, mistakes or oversights during the M&A process could result in expensive penalties. Fortunately, a thorough preparation and thorough documentation can help avoid these penalties.

As a general rule tax due diligence entails the review of previously filed tax returns, as well as current and historical informational filings. The scope of the audit depends on the nature of the transaction. For instance, acquisitions of entities generally have a greater risk of exposure than asset acquisitions, due to that tax-exempt entities could be susceptible to joint and several tax obligations of all the participating corporations. Other factors include whether a tax-exempt entity has been included on the Federal tax returns consolidated and the amount of documentation that is related to the transfer pricing of intercompany transactions.

A review of tax years will also reveal whether the company is in compliance with any applicable regulatory requirements and a variety of warning signs that may indicate tax evasion. These red flags include, but aren’t restricted to:

The final stage of tax due diligence is comprised of interviews with senior management. The aim of these discussions is to answer any questions that buyers may have, and to provide clarity on any outstanding issues that could affect the purchase. This is particularly important when acquiring companies with complex structures or uncertain tax positions.

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