Frequently encountered controversy issues in M&A transactions

Editor: Mo Bell-Jacobs, J.D.

The merger–and–acquisition (M&A) landscape is expanding as both publicly traded and privately held businesses consolidate and grow through M&As. M&A transactions help businesses scale operations, enter new markets, and expand globally. With M&A transactions on the rise, tax controversy professionals are frequently asked to assist with certain due–diligence issues. For example, during the due–diligence process, the parties to a transaction may seek confirmation of historical entity elections, confirmation of form filing requirements, and employer identification number (EIN) and name matching, with added complexities involving partnership continuation transactions, among others. For tax professionals to help preserve transaction value and mitigate risks, it has become increasingly important for them to identify these common issues and understand how to address potential IRS issues.

Certain issues that are discovered during the due–diligence process cannot be resolved immediately. Tax practitioners need to know how the issue can be resolved so the parties can specify an indemnification provision in the purchase agreement. Some of the more common tax controversy issues that can arise with the IRS between the buyer and the seller during the due–diligence process can create significant financial exposure for the buyer, including post–closing tax assessments, penalties, and rejected post–closing tax returns.

This item takes a closer look at prevalent issues in M&A transactions on which tax controversy professionals can provide support to their clients.

Verification of the entity status and form filing requirements

A foundational step in the due–diligence process involves verifying the target’s historical tax status and key elections. It is all too common for a company to believe it has filed an election to be taxed a certain way for federal tax purposes — only to discover that the required forms were never filed, were filed incorrectly, or were invalidated by a subsequent event. To verify compliance, practitioners can request tax account transcripts. Tax practitioners can also receive certain IRS modules via fax to verify entity status and election status. One of the modules is ENMOD (Entity Module), as described in Internal Revenue Manual (IRM) Section 2.3.15 (Jan. 1, 2019).

The ENMOD screen print, which is colloquially referred to as a transcript or a report, contains information about the entity’s status and whether the taxpayer has filed Form 8832, Entity Classification Election; Form 2553, Election by a Small Business Corporation; or Form 8869, Qualified Subchapter S Subsidiary Election. Tax professionals can also confirm the entity’s tax year end and whether it has filed Form 1128, Application to Adopt, Change, or Retain a Tax Year. The ENMOD can also specify the name of a parent corporate entity. All this information is crucial to confirm when a buyer is performing due diligence on a target entity.

The format of the ENMOD is not intuitive. Many ENMOD entries are coded to denote various entity attributes. These codes can be deciphered by consulting Section 8A of IRS Document 6209, ADP and IDRS Information, which is available as a publication on the irs.gov website.

A business entity transcript, described in IRM Section 21.2.3.2.6, Modified Business Entity Transcript and Business Entity Transcript (April 23, 2025), is also available to tax practitioners with a Transcript Delivery Service account. This transcript is generated in a more user–friendly format than an ENMOD report, though it contains less information. The business entity transcript contains the IRS establishment date, business operational date, form filing requirements, and exempt organization status. Tax practitioners may still need to obtain an ENMOD report to verify whether certain elections were filed and to verify other entity data that is not reported on the business entity transcript.

Navigating missed election relief

After reviewing the ENMOD transcript, tax practitioners may discover that certain entity elections are either missing or were filed late. This may not necessarily derail a transaction. Regs. Secs. 301.9100–1 through 301.9100–3 provide a powerful mechanism for obtaining relief and granting extensions of time to make certain regulatory elections if the filing deadline has passed. This relief is generally available in two forms: automatic and discretionary.

Automatic relief: Several revenue procedures grant automatic relief for common missed elections, provided the taxpayer meets specific requirements and takes corrective action within a prescribed time frame. This path avoids the cost and delay of seeking a private letter ruling to fix a missed regulatory election, including the following:

• Sec. 338 elections (Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases): Rev. Proc. 2003-33 provides an automatic 12-month extension to file a Sec. 338(g) or 338(h)(10) election. This 12-month extension is triggered as of the date of discovery of the missed election — not the original due date of the Form 8023 or the date of the transaction.
• Entity classification (Form 8832):Rev. Proc. 2009-41 grants an extension of three years and 75 days for an eligible entity to file an initial classification election or change its classification — provided there was reasonable cause and the entity has filed its prior years’ tax returns consistently with the intended classification. The three-year-and-75-day extension commences from the election’s effective date.
• S corporation election (Form 2553): Rev. Proc. 2013-30 provides a similar three-year-and-75-day window for late S corporation elections, requiring reasonable cause and consistent S corporation reporting by both the corporation and its shareholders.

Discretionary relief: If the requirements for automatic relief are not met, a taxpayer may still request discretionary relief under Regs. Sec. 301.9100–3 by requesting a private letter ruling. This requires a comprehensive disclosure of the facts and circumstances of the missed election, along with a demonstration that the taxpayer acted reasonably and in good faith. It must also include a statement, signed under penalties of perjury, that granting relief will not prejudice the interests of the government.

Changes to the entity status due to various tax-free reorganizations

One type of tax–free reorganization that is frequently encountered by tax controversy professionals in M&A transactions is known as a Type F reorganization (F reorg.), which is defined in Sec. 368(a)(1)(F). An F reorg. allows a target company to change its legal form or state of incorporation in a tax–free manner immediately before a sale, but it also requires affirmative updates to the IRS’s records.

A common application involves an S corporation target. The shareholders of the target S corporation may form a new holding company (NewCo) and contribute their target stock to NewCo in exchange for NewCo stock. With this step, the original target becomes a disregarded entity of NewCo, which enables the original target to convert into a limited liability company (LLC). This structure qualifies as an F reorg. and allows the shareholders to sell the stock of NewCo while providing the buyer with a step–up in the basis of the underlying assets (via the LLC).

Unless the taxpayer properly notifies the IRS about the transaction, the IRS cannot know that the S corporation became a disregarded entity for tax purposes because the entity has a new parent, which is the entity with the new income tax return filing requirement. A failure to properly notify the IRS of the transaction and the change in filing requirements can result in IRS inquiries into why no S corporation tax return was filed for the tax year following the transaction. The proper way to notify the IRS Entity Unit is to fully describe the transaction and provide relevant documentation of both the transaction and the change in entity status — including copies of the state registration documents and the reorganization agreement.

Addressing S corporation deficiencies

S corporations are a frequent source of due–diligence issues due to their strict eligibility and procedural requirements. These deficiencies generally fall into two categories: inadvertent errors on the election form and inadvertent terminations of S status.

• Inadvertent errors and omissions: Simple procedural mistakes on Form 2553 may be perfected without filing a private letter ruling request for relief. For example, missing shareholder consents that are discovered within the three-year-and-75-day window are available for late election relief under the simplified method of Rev. Proc. 2013-30. More recently, Rev. Proc. 2022-19 established procedures for correcting a range of nonsubstantive errors, such as a missing officer signature or an error regarding a permitted year — without requiring a private letter ruling. Nonsubstantive errors may be corrected under Rev. Proc. 2022-19 by submitting a written explanation of the error and available corrective measure to the IRS Service Center where the Form 1120-S, U.S. Income Tax Return for an S Corporation, is filed or an address provided in Rev. Proc. 2022-19.
• Inadvertent terminations: An S election can terminate if the corporation ceases to meet the definition of a “small business corporation” (e.g., by having an ineligible shareholder or more than one class of stock). If this termination is deemed inadvertent, Regs. Sec. 1.1362-4(a) allows the IRS to waive the terminating event and treat the corporation as continuing its S status. Relief for an inadvertent termination under Regs. Sec. 1.1362-4(a) is discretionary and is available via letter ruling. The following elements must be satisfied:
  1. A valid S election was terminated;
  2. The IRS determines the termination was inadvertent;
  3. The corporation took steps to correct the terminating event within a reasonable period after its discovery; and
  4. The corporation and its shareholders agree to any adjustments required by the IRS. (For more, see Nitti, “How S Elections Go Wrong and How to Fix Them,” 56-5 The Tax Adviser 52 (May 2025)).

Ensuring partnership continuation

For transactions involving partnership consolidations, tax practitioners must confirm the entity’s continued existence for tax purposes. The general rule under Sec. 708 is that a partnership continues if the trade or business is carried on by any of the partners. But the circumstances surrounding partnership continuations are nuanced, so tax practitioners must first confirm that the underlying transaction has resulted in a partnership continuation.

Controversies from partnership continuations arise because there is no efficient method to notify the IRS of a partnership continuation. The AICPA, in a comment letter, suggested that the IRS include a checkbox on Form 1065, U.S. Return of Partnership Income, to designate a partnership continuation filing.

Furthermore, although Regs. Sec. 1.708–1(c)(2) states that the resulting partnership shall retain the EIN of the original partnership, there is conflicting guidance regarding whether a continuing partnership should use the EIN of the original partnership or a newly established EIN of the resulting partnership. To mitigate any confusion regarding whether the EIN either survives or replaces that of the original partnership, the AICPA comment letter also proposes allowing the resulting partnership to notify the IRS of this decision in the form of an election. In a manner consistent with the recommended continuing partnership notification checkbox on Form 1065, the AICPA suggests that the IRS include an additional checkbox denoting the taxpayer’s decision to use the original or new EIN.

In practice, following Sec. 708 regulations and allowing the resulting partnership to use the EIN of an acquired partnership can result in two separate entities using the same EIN — where the resulting partnership is using the EIN for the purpose of federal tax return filing (Form 1065), while the acquired partnership, which is usually the operating entity, continues to use the same EIN for employment tax filings, state filings, and information return filings. Though permissible under Sec. 708, this application can be problematic if the previously acquired partnership is later sold to a different entity. At that point, the acquired entity will need to continue using its EIN, while the former partnership that previously shared the acquired partnership’s EIN will need to dissociate from using the operating entity’s EIN.

The AICPA comment letter addresses this conundrum resulting from conflicting IRS guidance. Until the IRS addresses whether taxpayers may elect to use either the assigned EIN or follow Sec. 708 and establishes more efficient means of notification and updating the taxpayer’s account, taxpayers will need to notify the IRS’s Entity Unit about the partnership continuation and the election to use either the assigned EIN or the acquired entity’s EIN.

Increasingly complex transactions

The increasing complexity of M&A transactions demands a higher level of tax scrutiny from advisers. By understanding the common pitfalls related to entity elections, S corporation status, partnership continuity, and corporate reorganizations, tax professionals can embrace a more proactive role in these matters. Proactively identifying these issues during due diligence and applying the appropriate corrective measures — whether through automatic relief procedures or a formal private letter ruling request — is essential for mitigating risk, preserving transaction value, and delivering superior client service in the modern M&A environment.

Editor

Mo Bell-Jacobs, J.D., is a senior manager, Washington National Tax, with RSM US LLP and a member of the AICPA Tax Executive Committee.

For additional information about these items, contact Bell-Jacobs at Mo.Bell-Jacobs@rsmus.com.

Contributors are members of or associated with RSM US LLP.