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Tax Due Diligence for Potential Buyers of Existing Businesses

12.17.2018

When a buyer is evaluating an existing business for possible purchase, there are many factors to consider. Buyers must consider the business’s existing cash flow, evaluate competition in the market, and assess current levels of inventory and staffing. They must also determine what fixtures, furniture and equipment the business currently possesses, in addition to analyzing other key metrics, before deciding on a fair price for the business and making an offer. However, with new IRS audit rules regarding tax liabilities for partnerships, buyers may find themselves liable for something they had not considered—taxes and penalties incurred prior to their investment or involvement with the business.

These new IRS audit rules state that if there is an audit of a prior-year return, any adjustments for the prior year must be paid by the LLC or partnership in existence in the year that the adjustment is finalized. This could leave you, as a new business owner, responsible for taxes and fees you were not party to incurring. Meanwhile, the previous business owner escapes liability for any taxes, penalties and interest owed.

Assessing the potential for future tax liability is now a vital part of any calculation regarding the purchase of an existing business. So how do you evaluate the tax health of a business and factor the potential problems found during an IRS audit into your offer price? These new audit rules underscore the importance of having tax and transaction advisors who are experienced in these types of business valuations to help guide you through the process.

Do Your Due Diligence

A good first step for a potential buyer is performing an ASC 740 analysis to find out the potential universe of liability the business could have. A buyer must have a thorough understanding of the business’s operations, which includes an assessment of tax liability and risk.

Once potential risk has been identified, it’s important to quantify the level of risk. What are the potential adjustments, penalties and interests associated with the business?

When you’ve identified the potential liabilities, you’ll need to be able to explain those risks to the seller and communicate effectively about how that risk has affected your offer price. Sellers may not be aware of these audit rules. They also may not realize that their business is worth less than they thought when these risks are factored in, so seller education can be a big part of this process.

Are you considering purchasing an existing business, or do you need help amending current LLC and partnership agreements to address these new audit rules? Contact us to get started on a plan to evaluate and mitigate your risk for future tax liability. For more information, contact Patrick McGuire, Tax Principal, at 314.687.2389 or pmcguire@bswllc.com

To learn more about our services for the private equity industry, contact Bryan Graiff, Private Equity Industry Group Leader at bgraiff@bswllc.com or 314.983.1390.

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