Preparing and Filing Tax Returns

Virtually all merger agreements include a tax matters section in which obligations related to the post-closing preparation, review and filing of pre-closing and straddle period tax returns are clearly specified. These sections of the merger agreement may also clarify which party is responsible for any taxes required to be paid post-closing as a result of pre-closing activity, and which party may get the benefits of certain tax issues such as net operating loss carryback refunds, collection of pre-closing tax year refunds, or overpayment of estimated taxes.

Though it may seem simple, it is impractical for the shareholder representative to prepare the tax return.

It is often appropriate for the shareholder representative to have a role in reviewing and approving any tax return related to pre-closing activity, especially if the return would result in either a payment by the shareholders for taxes due or receipt of a tax refund due the shareholders. Merger agreements, however, sometimes suggest that the shareholder representative will be responsible for the post-closing preparation and filing of pre-closing tax returns. Buyers may request this for their own convenience, since any taxes owed on the return are likely indemnified against by the selling shareholders.

Though it may seem simple, it is usually impractical for the shareholder representative to prepare the tax return. First, this is the company’s tax return and, unless the transaction was structured as an asset sale, the filing entity has been merged into the buyer. Therefore, it is the surviving entity’s legal obligation to file any tax return post-closing. Second, the shareholder representative cannot sign it. Tax returns of a corporation must be signed by an officer or director of the corporation. Neither the shareholder representative nor the former shareholders are the taxpayer or an agent of the taxpayer.

As a practical matter, even if the representative could somehow prepare and file the return, the books and records necessary to prepare it now belong to the buyer. More importantly, the confidential relationship with the company’s prior tax preparers is also now owned by the buyer. Finally, most tax preparers (especially the major accounting firms) require a relationship with the taxpayer, which, at this point, is the surviving entity.

Sellers should try to provide their representative with the last three years of tax reporting as well as audited annual and non-audited interim financial statements.

Who pays for tax preparation, and who is responsible for paying pre-closing taxes or has ownership of any tax benefits, can be subjects of negotiation. If shareholders have tax obligations or rights, all applicable tax returns required to be filed post-closing should be approved by the shareholder representative and subject to the dispute resolution mechanism specified in the merger agreement.

To facilitate the shareholder representative’s review of the pre-closing tax returns, the parties should define the information rights of the representative post-closing, including what constitutes reasonable access to the books and records of the surviving corporation and reasonable consultation rights with the buyer’s finance/tax staff and outside tax preparer. The sellers should also provide their representative with the last three years of tax reporting as well as audited annual and non-audited interim financial statements. These statements contain important information regarding the target company’s past accounting practices and prior determinations made by management. Sellers should consider requesting that the pre-closing tax return be prepared by the same firm that prepared the last tax return filed by the taxpayer prior to closing and that any subsequent returns be prepared in a manner consistent with that return. Finally, because closing date tax returns may include transactions that only occur as a result of the merger, the parties should define which taxable income, expenses or net operating losses are to be included or excluded from calculations for purposes of any purchase price adjustments or possible indemnification claims.

SRS Acquiom notes that in circumstances where the target company was a partnership or an LLC taxed as a partnership, the selling parties properly want control of the preparation of the tax return because taxes are required to be reported and paid on each partner’s or member’s individual tax returns. In these cases, the parties should negotiate a broad cooperation agreement with respect to the preparation and filing of the target’s tax return and ensure that any engagement agreement between the target and its tax preparer include the shareholder representative as a party or third-party beneficiary entitled to give direction.

Paul Koenig

Chief Executive Officer tel:303-957-2850

Paul is the chief executive officer and co-founder of SRS Acquiom.

Before co-founding SRS Acquiom, Paul was one of the founding partners of Koenig & Oelsner, a Denver-based corporate and business law firm with a strong practice in mergers and acquisitions, securities, and financing transactions. Prior to that, he was an attorney in the Chicago office of Latham & Watkins, and in the Colorado office of Cooley LLP.

Paul has authored numerous articles and is a frequent speaker at industry events. He received his BBA in finance from the University of Iowa and graduated from Northwestern University School of Law.

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