Tax due diligence (TDD) is among the least considered – and yet one of the most important aspects of M&A. Because the IRS is unable to conduct an audit of each company in the United States, mistakes or oversights in the M&A process could result in expensive penalties. Thankfully, proper preparation and meticulous documentation can prevent these penalties.
As a general rule tax due diligence is the review of prior filed tax returns, as well as current and historical informational filings. The scope of the audit differs based on the type of transaction. For example, entity acquisitions generally have a greater risk of exposure than asset purchases, given that taxable target entities can be susceptible to joint and several tax obligations of all the participating corporations. Other factors include whether a taxable entity is included in consolidated federal tax returns and the amount of documentation pertaining to transfer pricing for intercompany transactions.
A review of tax years prior to the year can help determine if the company is in compliance with regulations as well as a few red flags that could indicate tax abuse. These red flags could include, but aren’t limited to:
The final phase of tax due diligence is comprised of interviews with senior management. The purpose of these meetings is to answer any questions buyers may have, and also to provide clarity on any issues that may impact the deal. This is especially important when dealing with acquisitions that have complex structures or uncertain tax positions.
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