Tax due diligence is an important aspect of M&A that is often ignored. The IRS can’t audit every firm in the United States. Therefore, mistakes and oversights that occur during the M&A processes could result in significant penalties. A well-planned and meticulously documented process can aid in avoiding these penalties.

As a general rule, tax due diligence encompasses the review of previously filed tax returns, as well as current and historical informational filings. The scope of the audit varies dependent on the nature of transaction. For instance, entity acquisitions typically involve greater potential exposure than asset purchases, due to the fact that taxable targets may be subject to joint and several liability for the taxes of all participating corporations. Furthermore, whether a link taxable target is listed in the federal income tax returns that are consolidated and whether it has the proper documentation regarding transfer pricing related to intercompany transactions are other factors that can be scrutinized.

Examining tax returns from prior years can help determine if the company is in compliance with regulations as well as some red flags that may indicate tax evasion. These red flags may include, but not be restricted to:

Interviews with top managers are the final step in tax due diligence. The goal of these interviews is to answer any questions that the buyer may have and to clarify any issues that may affect the purchase. This is especially important when dealing with acquisitions that have complicated structures or uncertain tax positions.