Tax Due Diligence in M&A Transactions

Tax due diligence is a crucial aspect of M&A which is often neglected. Because the IRS cannot practically conduct an audit of tax compliance for every company in the United States, mistakes or oversights during the M&A process can lead to severe penalties. Thankfully, proper preparation and meticulous documentation can prevent these penalties.

As a general rule tax due diligence covers the review of prior filed tax returns, as well as current and historical informational filings. The scope of the audit varies dependent on the nature of transaction. Entity acquisitions, for example are more likely to expose the company to liability than asset purchases because target companies that are tax deductible may be jointly and severally responsible for the taxes of the participating corporations. Also, whether a tax-exempt target is included in the federal income tax returns that are consolidated as well as the quality of transfer pricing documentation related to transactions between companies are other factors that may be reviewed.

A review of tax years prior to the year can also reveal if the target firm is in compliance with the regulations and also a few red flags that indicate possible tax fraud. These red flags may include, but aren’t specific to:

The final phase of tax due diligence is comprised of interviews with top management. These meetings are designed to answer any queries the buyer may have and to discuss any issues that could affect the purchase. This is especially important in acquisitions that involve complicated structures or uncertain tax positions.

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