How essential is tax diligence for an asset deal?

September 20, 2024

by a searcher in Washington, DC, USA

Currently in discussions to acquire a ~$5M business with $10M in revenue, have legal diligence and accounting diligence (QofE) covered, but was wondering how often others use tax diligence for their transactions especially at this small of a size pre-close. Deal is structured as an asset purchase and I am trying to be mindful of fees, but don't want to be penny wise pound foolish.

If I do require tax diligence, what is the minimum type of scope that should be covered?

The target has accountant reviewed financials and has a CPA file their tax returns.

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Reply by a professional
from Harvard University in Lynbrook, NY 11563, USA

Google “liability for taxes on purchase of assets” and read a few of the articles. Sales and payroll taxes appear to be the main potential concerns. The more states the business significantly touches for sales or employment, the more potential exposure. Many states allow you to get a clearance certificate of one form or the other on sales taxes which would protect you from exposure to that liability. Payroll will depend on where your employees are located. You can consider in light of this if you think the business might have exposure and do a high level consultation with someone knowledgeable but honest enough to tell you what you need. Maybe an accountant who understands this well but doesn’t exclusively do this. (The articles you’ll find are largely written by tax diligence providers.)

Also depends what you’re holding onto for indemnity purposes and for how long (e.g., if you have a significant ten year seller note you might not worry so much).

Reply by a searcher
from The University of Chicago in San Antonio, TX, USA

If your QOE peeps aren't looking at taxes, that's a red flag ... Ideally, we want audited financials AND tax returns. 9 times out of 10, we only get our hands on taxes. Most SMBs don't have audited financials - heck, some don't have financials. Taxes aren't fail-proof - you can make a mistake. Intentional "mistakes" = fraud. Unintentional - there are usually straightforward ways to remedy. Either way, the exercise of triangulating financials with performance with tax returns (and/or audited financials) is our QOE. DM me to chat more!

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