Tax Due Diligence in M&A Transactions

Tax due diligence (TDD) is among the most overlooked – and yet crucial – elements of M&A. The IRS isn’t able to audit every single company in the United States. Therefore, mistakes and oversights made during the M&A processes could result in heavy penalties. Thankfully, proper preparation and complete documentation can help you avoid these penalties.

As a general rule tax due diligence entails the review of previous tax returns as well, as well as current and historical informational filings. The scope of the audit varies according to the type of transaction. For instance, acquisitions of entities typically have greater risk than asset purchases, given that taxable target entities may be subject to joint and several obligation for taxes of all participating corporations. Other factors include whether a taxable entity has been included on the combined federal tax returns and the amount of documentation related to the transfer pricing of intercompany transactions.

Reviewing tax returns from prior years will also reveal whether the target company complies with any applicable regulatory requirements, as well as a number of red flags indicating possible tax abuse. These red flags may include, but need not be only:

The final stage of tax due diligence is comprised of interviews with top management. The goal of these interviews is to answer any questions that the buyer might have, and to provide a clear understanding of any issues that might influence the sale. This is especially important when acquiring companies with complex structures or uncertain tax positions.

the intersection of AI and VDRs in enhancing due diligence