Tax due diligence (TDD) is one of the least studied – but yet one of the most important aspects of M&A. Because the IRS cannot effectively conduct a tax audit of every company in the United States, mistakes or mistakes made during the M&A process could lead to expensive penalties. Proper preparation and thorough documentation will ensure that you don’t incur these penalties.

Tax due diligence is generally the examination of tax returns as well as other informational filings from both current as well as past years. The scope of the audit varies dependent on the nature of transaction. For instance, acquisitions of entities typically have greater risk than asset acquisitions, due to that taxable targets may be subject to joint and multiple obligation for taxes of all participating corporations. Other factors include whether a taxable entity has been included in the combined federal tax returns and the amount of documentation regarding transfer pricing for intercompany transactions.

Reviewing prior tax years can reveal whether the company is in compliance the regulations and also some red flags indicating possible tax fraud. These red flags include but are not limited to:

The final phase of tax due diligence is comprised of a series of meetings with top management. The goal of these interviews is to answer any questions that the buyer may have and also to provide clarity on any issues that are not resolved that could influence the sale. This is especially important when purchasing companies with complex structures or tax positions that are unclear.

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