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The need for tax due diligence isn’t always top of mind for buyers who are focused on 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 on the acquisition.
Tax due diligence is vital, regardless of whether the company is C or S, a partnership, an LLC or a C corporation. They generally do not pay entity level tax on their net income. Instead net income is distributed to members, partners or S shareholders (or at higher levels in a tiered structure) for taxation of individual ownership. Due diligence should include a study of the possibility of an assessment of additional corporate income taxes by the IRS or other state or local tax authorities (and the associated interest and penalties) due to of incorrect or erroneous positions discovered in audit.
Due diligence is more crucial than ever. More scrutiny by the IRS of unreported foreign bank and other financial accounts, the expansion of state bases for sales tax nexus as well as changes in accounting methods, as well as an increasing number jurisdictions that have laws against unclaimed property, are just a few of the numerous issues that must be considered as part of any M&A transaction. Circular 23 can impose fines on both the person who signed the agreement as well as the non-signing preparedr if they fail to adhere to the IRS’s due diligence requirements.