Due diligence is a crucial part of tax preparation. It’s more than a good practice; it’s an ethical requirement to protect yourself and your client from the hefty penalties and liabilities. Tax due diligence is complicated and requires a high level of care, which includes looking over information from clients to ensure that it’s true.
A thorough review of the tax records is essential for an effective M&A deal. It can help a company negotiate a fair price, and also reduce the cost of integration after the deal. It can also identify compliance issues which could impact the structure of a deal or its valuation.
A recent IRS ruling, for example it stressed the importance of looking over documents to back up entertainment expense claims. Rev. Rul. 80-266 states that “a preparer is not able to meet the general standard of due diligence merely by inspecting the organizer of the taxpayer and confirming that all the expense and income entries are accurately reported in taxpayer’s supporting material.”
It’s also important to review the unclaimed property compliance requirements and other reporting requirements for domestic and foreign organizations. These are subjects that are increasingly under scrutiny by the IRS and other tax authorities. It is also necessary to analyze a company’s performance in the market, and note developments that could impact the financial performance metrics and valuation. If, for example, an oil retailer was selling at an overpriced margin in the industry its performance metrics could deflate when the market returns to normal pricing. Doing tax due diligence could help to avoid these unexpected surprises and provide the buyer with the assurance that the purchase will go smoothly.
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