Tax Due Diligence in M&A Transactions

Tax due diligence (TDD) is among the most overlooked – and yet the most crucial – aspects of M&A. Because the IRS cannot practically 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 well-planned preparation and detailed documentation can assist you in avoiding these penalties.

As a general rule tax due diligence is the examination of previously filed tax returns as well as the review of current and historical informational filings. The scope of the review differs based on the type of transaction. For instance, entity acquisitions typically involve greater potential exposure than asset purchases, due to the fact that taxable target entities may be subject to joint and multiple liability for the taxes of all the participating corporations. Additionally, whether a tax-exempt target is included in consolidated federal income tax returns as well as the quality of documents relating to transfer pricing in intercompany transactions, are additional factors that can be scrutinized.

A review of tax years will also reveal if the company in question is compliant with any applicable regulatory requirements and a number of red flags that could indicate tax evasion. These red flags may include, but are not tax preparation due diligence only:

Interviews with top management personnel are the final step in tax due diligence. The purpose of these meetings is to answer any questions that the buyer may have and also to provide clarity on any issues that may affect the transaction. This is particularly important when purchasing companies that have complex structures or uncertain tax positions.