Tax Diligence
Buy-side and sell-side tax due diligence that identifies exposures and structuring issues before they affect price or terms.
Overview
Tax issues in a target company can follow the buyer after closing, especially in stock deals. Tax due diligence reviews a company’s filing history, positions, and structure to identify exposures before a transaction closes, so they can be reflected in price, indemnities, escrows, or deal structure. On the buy side, we help acquirers and their lenders understand what they are taking on. On the sell side, we help owners find and address issues before a buyer does.
Tax diligence typically runs alongside financial diligence such as a Quality of Earnings analysis. Quality of Earnings focuses on the sustainability of earnings; tax diligence focuses on historical tax exposure and how the deal’s structure will be taxed. Our work commonly covers federal income tax compliance, state nexus and unfiled returns, sales and use tax, payroll tax, and the validity of S corporation elections.
How We Help With Tax Diligence
Buy-Side Tax Diligence
Reviewing a target’s tax returns, filings, and positions to identify historical exposures, quantify them where possible, and highlight items to address through price, indemnification, or structure.
Sell-Side Tax Diligence
Reviewing your own company before a sale to identify and correct tax issues in advance, reducing the risk of surprises that can delay a deal or change its terms.
State Nexus Exposure
Assessing where the target may have unfiled income, franchise, or sales tax obligations based on its activity, and estimating the potential exposure, including tax, interest, and penalties, across states.
S Corporation Validity Review
Testing whether an S corporation election was properly made and maintained, including shareholder eligibility and single-class-of-stock issues that can affect deal structure and planned tax elections.
Structuring Considerations
Analyzing tax effects of asset purchases, stock purchases, and elections that treat a stock deal as an asset deal, along with rollover equity and purchase price allocation.
Coordination With QoE
Working alongside Quality of Earnings and financial diligence teams so tax findings, tax accruals, and related normalization adjustments are consistent across the full diligence report.
Challenges We Help You Address
- ✓Unknown tax exposures in a target that could transfer to the buyer
- ✓Sales or income tax obligations in states where the target never filed
- ✓S corporation elections with defects that affect planned deal structure
- ✓Choosing between asset and stock structures without modeled tax effects
- ✓Sellers caught off guard by tax issues raised late in a deal
Frequently Asked Questions
What is tax due diligence?
Tax due diligence is a review of a company’s tax filings, positions, and structure performed in connection with a transaction. Its purpose is to identify historical tax exposures and structuring issues that could affect the deal. Findings are typically used to negotiate price, indemnities, escrows, or representations, or to adjust the structure. It covers income tax and often sales and use, payroll, and other taxes.
What is the difference between tax due diligence and a Quality of Earnings report?
A Quality of Earnings analysis evaluates the sustainability and accuracy of a company’s reported earnings, often adjusting EBITDA for non-recurring or non-operating items. Tax due diligence focuses on historical tax compliance, unrecorded tax exposure, and how the transaction will be taxed. The two are complementary and are frequently performed together so financial and tax findings are consistent.
Why does S corporation validity matter in an acquisition?
Buyers often rely on a target’s S corporation status, for example when using an election that treats a stock purchase as an asset purchase for tax purposes. If the S election was invalid or terminated because of an ineligible shareholder or a second class of stock, the company may have been a C corporation, creating corporate-level tax exposure and limiting structuring options. Diligence tests for these issues.
Should a seller do sell-side tax diligence?
Sell-side tax diligence can help owners identify and address issues such as unfiled state returns, payroll tax problems, or S corporation defects before buyers find them. Resolving issues in advance, or at least understanding them, can help reduce the risk of renegotiation, delays, or larger escrows. It also helps sellers anticipate how buyers may view the company’s tax history.
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