Tax Due Diligence in M&A Transactions

Due diligence is a vital aspect of preparing a tax return. It’s not just a good practice; it’s an ethical necessity to safeguard you and your client from costly penalties and liabilities. But tax due diligence is complicated and requires a high level of care, which includes checking the information of a customer to ensure that it’s accurate.

A thorough examination of tax records is essential to a successful M&A deal. It can aid a business negotiate an equitable deal and cut down on post-deal integration costs. Additionally, it can help identify compliance issues that could affect the structure of the deal and its valuation.

For instance, a recent IRS ruling highlighted the importance of examining documentation to support entertainment expense claims. Rev. Rul. 80-266 provides that “a preparer is not able to meet the general requirement of due diligence just by looking over the organizer of the taxpayer and confirming that all the entries for income and expenses are accurately reported in achieving success with secure digital rooms taxpayer’s supporting material.”

Also, it’s important to check the requirements for reporting for both foreign and domestic organizations. IRS and other tax authorities are more and more investigating these areas. It is important to also evaluate a company’s standing in the market, taking note of trends that may affect the valuation of financial performance and other metrics. For instance an oil retailer that was selling at an overpriced industry margins may see its performance metrics deflate after the market returns to normal pricing. Performing tax due diligence can help to avoid these unexpected surprises and give the buyer confidence that the deal is successful.