Tax Due Diligence in M&A Transactions

Tax due diligence (TDD) is among the least considered – and yet the most crucial – aspects of M&A. Because the IRS is unable to conduct an audit of tax compliance for every company in the United States, mistakes or mistakes during the M&A process can lead to expensive penalties. A thorough and well-organized process will ensure that you don’t incur these penalties.

Tax due diligence is typically the review of previous tax returns, as well as informational filings from the current as well as past years. The scope of the audit varies depending on the type of transaction. For example, entity acquisitions generally have a greater risk of exposure than asset acquisitions, due to that taxable target entities can be subject to joint and several tax liability of all corporations participating. Other factors include whether a tax-exempt entity has been included in Federal tax returns consolidated and the amount of documentation related to transfer pricing for intercompany transactions.

A review of tax years prior to the year can help determine if the company is in compliance regulatory requirements, as well as some red flags that could indicate tax fraud. These red flags may include, but need not be only:

The final stage of tax due diligence is comprised of interviews with senior management. These meetings are designed to answer any questions a buyer might have and to discuss any issues that could have an impact on the deal. This is particularly important when dealing with acquisitions that have complex structures or unclear tax positions.

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