Small Business Due Diligence – Verifying Seller’s Tax Returns via IRS 4506

When trying to buy a small business, it is important to do your Due Diligence to gauge the suitability of the business to your needs, and to make you are paying the appropriate price for the business.  One important step is to verify the tax returns that have been filed by the owner of the business.  Of course, if the seller hands you copies of the Tax Returns, should you just automatically assume that they are the actual Tax Returns that were filed?  You can verify what was actually filed by using the IRS Form 4506 & 4506T

What exactly is the IRS form 4506 & 4506T?  Simply put, they are the forms with which a copy of a tax return can requested from the IRS.  What this means is it is your chance to see what was actually filed with the IRS.  Lending institutions use these forms to verify what a potential borrower has filed.  In the case of an acquisition of a business, the banks will also use these forms to verify what the seller has filed with the IRS.  What is the difference between the two forms?  Glad you asked.  The 4506 is used to request photocopies of the actual return.  According to the IRS, it can take up to 6 weeks or even more for the photocopies to arrive.  The 4506T is used to request the transcript of the tax return requested.  The transcript is a summary of the return, so it won’t be the originals.  The tax transcripts have a much faster turnaround time, even possibly fast as a one day turnaround time.

Now, if a Bank makes a practice of using 4506s, then so should you.  You should consider using both forms.  You will likely get the tax transcripts before your Due Diligence period is finished.  The actual photocopies will likely come after you have finished your Due Diligence.  However, there would still be some value to the actual photocopies, if there were discrepancies then you would have some possible evidence of fraud or misrepresentation.  This should be handy in pursuing some remedy from the seller.

Another important note is that there was an issue a few years ago with Lenders and mortgage brokers asking/instructing  applicant borrowers being asked and/or instructed to not date the form.  The IRS is clear in this issue, that the form must be dated by the party whose tax returns are being requested.  Also, the form is only good for 120 days after it is dated and signed, so keep this in mind.  Insist on signing and dating your form if you are being requested to provide one.  Otherwise, the form is open to abuse by being repeatedly submitted after the 120 day deadline.

As always, consult legal and professional advice when involving yourself in business transactions.  This post is for informational purposes only.

For More information on how Just Elementary, Inc, Business Brokers can help you with Due Diligence  for  a business that you are contemplating purchasing, contact our Client Care Manager Sonia Chhabra at  (888) 926-9193 or email cs@justelementary.com