Tax diligence exists because in a share or membership interest sale the buyer inherits the company's tax history, and even in an asset sale some exposures follow the assets or the people. The work is a search for liabilities that have not yet been assessed.
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What is examined
Filings and payments for the open years, the treatment of any unusual items, worker classification where contractors are used, sales and use tax in every state where you have created a filing obligation, and any correspondence with a taxing authority. Multi state businesses attract the most attention because obligations are created by activity rather than by intention.
The exposures that recur
Contractors who should have been employees. Sales tax not collected in states where activity created an obligation. Personal expenses run through the company beyond what is defensible. Related party transactions without documentation. None of these is unusual in a private company and all of them are quantifiable, which is why they end up as indemnities rather than as reasons to walk away.
How they are handled
A quantified exposure becomes a specific indemnity, an escrow amount or a price adjustment. An unquantifiable one may become a condition, such as obtaining a ruling or filing amended returns before closing. A seller who has identified these in advance can propose the treatment rather than receive it.
Questions people ask about tax due diligence
Does an asset sale avoid tax diligence?
It reduces it but does not remove it. Employment tax and sales tax exposures can follow the business or the people, and the buyer will still look.
Should I get my own tax review first?
Where you know there are grey areas, yes. Finding and pricing them yourself is much cheaper than having them found under exclusivity.
Who does this work?
A tax specialist within the buyer's accounting firm, or your own where the seller is preparing a vendor pack.