IRS lacks strategy for dealing with tax compliance after M&A deals

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The Internal Revenue Service needs to have a better strategy for determining the tax compliance or noncompliance of corporations that do mergers and acquisitions, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, noted that corporate M&A deals can be large, complex transactions that potentially have big tax implications. While some transactions can be structured in a way to make them tax-free, it’s still important for the IRS to make sure complicated M&A transactions are in compliance with the tax laws and the appropriate amount of tax is paid.

The Institute for Mergers, Acquisitions, and Alliances reported there were 14,540 M&A deals in the U.S. last year, with a total value of nearly $1.9 trillion, TIGTA pointed out, and there have been approximately 120,000 domestic corporate M&A transactions in the past 10 years, totaling $15.3 trillion.

The Tax Code allows tax-free treatment for transactions that meet certain technical requirements, and corporate tax specialists sometimes make the form of the transaction appear to satisfy those requirements, even while the substance does not. The IRS’s Large Business and International Division has been transitioning to issue-based audits and has adopted a “campaign” approach to auditing specific issues in the realm of corporate tax compliance.

TIGTA examined the IRS’s approach to tax compliance after M&A deals and found the IRS doesn’t actually have an overall strategy to address potential tax noncompliance of M&A transactions. The IRS examination managers that TIGTA spoke with for the report claimed that issues related to M&A generally receive the same attention as any other issue.

IRS data indicate that adjustments were proposed in only 8 percent of the 4,965 instances in which M&A deals were potentially an issue in closed cases from fiscal years 2015 through 2018, or about 400 cases. When LB&I Division examiners were able to propose an adjustment to M&A issues, the proposed adjustments were significant, however: an average of approximately $15.2 million per issue.

The IRS does collect information on M&A deals from taxpayers who engage in those transactions, but doesn’t use it to identify potential noncompliance. Taxpayers who engage in a tax-free reorganization are supposed to notify the IRS on their next tax return by including a statement about it. But when TIGTA asked the IRS to provide the number of these statements filed for tax years 2015 through 2017, the IRS said that while these statements are part of the taxpayer’s return, it was unable to provide the information.

TIGTA recommended that the IRS LB&I Division set up a strategy for assessing compliance risk and promoting tax compliance in the M&A area, including determining if returns with high‑risk M&A transactions can be identified before they reach the field. TIGTA also suggested the IRS should determine whether the M&A tax forms, and the information provided on them, could be used as a compliance tool as part of a larger strategy to assess risk and ensure that corporate M&A transactions comply with the Tax Code.

The IRS disagreed with the first recommendation, but agreed with the second suggestion. The IRS said it already has a strategy consistent with the goals of the recommendation. TIGTA, for its part, said it believes the approaches to M&A transactions described by the IRS have been limited, separate and distinct from each other and support the need for a consolidated strategic approach.

“We will continue our focus on M&A issues, and refine our existing strategy based on our experience, findings and changes in the law,” wrote Douglas W. O’Donnell, commissioner of the IRS LB&I Division, in response to the report. “It is important for us to broadly allocate our limited examination resources to have a compliance impact across all areas of noncompliance, and to tailor our efforts and resource allocation according to the level of compliance risk presented by a particular issue.”

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M&A Corporate taxes IRS TIGTA Tax strategies