So You Think You Are Ready for Due Diligence?

March 6, 2018

At the stage of a company’s development where it is advantageous to think about the sale of all or part of the business to a financial or strategic buyer, management teams are generally prepared to undergo a certain amount of due diligence from the buyer organization. Government contractors expect to undergo close examination of their accounting records, contract files, HR files, legal contracts, and other files and records.

Many government contractors do not think that their tax files and practices will present areas of great concern, but often these areas can lead to unpleasant surprises for selling organizations. Specifically, here is a sampling of areas that often create unpleasant surprises:

  • Have you had someone review your original documents, filings or election forms related to your entity type? Especially if your entity is an S corporation or a LLC being taxed as a corporation, there are numerous areas where buyers can find gaps in the timing or accuracy of tax elections that may not have been done properly. With the passage of time, documents are sometimes lost or misplaced and create the need to seek special relief under the Internal Revenue Code for elections not properly documented.
  • Have you had someone review your tax filings with an eye toward compliance with state filing requirements? Government contractors are often asked by agency customers to perform services in numerous locales. Contractors often believe that they do not trigger a state income tax filing requirement until they either have a physical presence or an employee presence in a given state. This is often not the case, and buyers will focus on whether a selling organization has considered the tax implications of performing services, often for a relatively short period, in a state where no tax filing has been made.
  • Have you had someone review compliance with sales and use tax requirements? Many government contractors overlook sales and use tax requirements on the premise that “we are selling to the Federal government and are exempt from sales tax.” While this is generally a true statement, every state can have different criteria around what types of sales to the U.S. government are exempt from state sales tax, and buyers will be rightfully concerned about stepping into unknown sales tax liability because the selling organization has never considered the impact of product sales to agency customers.

Other areas of focus include international tax liabilities for products or services delivered abroad, personal and real property taxes, and the potential improper classification of employees versus 1099 subcontractors. You may have heard your grandparent say “An ounce of prevention is worth a pound of cure,” and pre-screening of potential tax diligence items falls in this category.

For any questions, feel free to contact one of our experienced GovCon professionals.