Tax due diligence (TDD) is one of the most overlooked – and yet one of the most important aspects of M&A. Because the IRS can’t effectively conduct an audit of tax compliance for every company in the United States, mistakes or oversights during the M&A process could lead to expensive penalties. A thorough and well-organized process can assist you in avoiding these penalties.

Tax due diligence generally refers to the review of previous tax returns and documents pertaining to information from current and historic periods. The scope of the audit differs depending on the type of transaction. For instance, acquisitions of entities are more likely to expose the company’s assets than asset purchases because targets that are tax-exempt may be jointly and jointly liable for the tax liabilities of the participating corporations. Also, whether a tax-exempt target is included in the consolidated federal income tax returns as well as the quality of documentation regarding transfer pricing related to intercompany transactions are additional aspects that could be examined.

Reviewing tax returns from prior years will also reveal whether the company is in compliance with the regulations applicable to it as well as a number of warning signs that may indicate tax fraud. These red flags include, but aren’t restricted to:

The final phase of tax due diligence is comprised of interviews with top management. The purpose of these meetings is to answer any questions buyers may have, and to clarify any issues that might impact the deal. This is especially crucial when purchasing companies with complex structure or uncertain tax positions.

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