Taxpayers may encounter a variety of challenges as the IRS is facing one of its smallest (and least experienced) workforces since the 1970s. Continuing the theme of our previous article authored by Robert Romashko, the following discussion highlights some specific tax diligence areas of concern in the healthcare space. The problems of a very outdated IT system still exist – the IRS still uses fax machines in communications with taxpayers.

Specific actions healthcare (and other) organizations considering M&A transactions may want to begin to take now include:

• Start working to clear any outstanding tax liens and levies early. Buyers and investors often expect a debt-free balance sheet from their targets. Sometimes outstanding tax liens may be forgotten, particularly in complex corporate structures with dormant entities. To avoid diligence annoyances in a fast-paced M&A transaction, clients should run UCC lien searches and ensure nothing unexpected arises.

• Ensure copies of tax returns, S corporation election letters and other confirmatory IRS letters, such as tax-exempt determination letters, are available. Buyers often request items such as proof of an S corporation election (it is often not enough just to show the Form 1120-S). The IRS’s web site does have guidance on requesting such items from the IRS if missing, but the time to get copies will be extended to many months (and this process was rarely quick to begin with).

• Ensure the tax compliance team and internal or external tax return preparers are using the correct and current legal name for your organization on the organization’s tax return to ensure the IRS updates its records due to legal name changes.  Healthcare organizations experience headaches as payors and licensing entities will often insist on exact matches between a corporate legal name and the federal employer identification number (EIN, also referred to as TIN in IRS authorities). When legal names change, the IRS can be very slow to update them via the traditional route of sending written correspondence and powers of attorney to one of the IRS’ EIN offices. The best way to handle mismatches is to ensure CPAs know of the legal name change and do not continue to use the old name in tax filings – it’s possible the tax return processing systems will update the names simply as a matter of course when processing the tax returns. It is likely that an actual tax return will be filed and processed before anyone at the IRS division responsible for EINs will help update the legal name.

• Along the same lines, the IRS will be extremely slow to update tax-exempt determination letters with new legal names – prepare to explain why there is a mismatch.  Donors to tax-exempt organizations should be asked not to insist on matching documentation if a legal name change was done relatively recently. Donors should be satisfied with a current determination letter (as well as exempt status under the IRS Select Check tax-exempt verification site) and a file-stamped articles of amendment proving the legal name change from the previous name. If not, for major donors, consider whether an opinion of counsel will suffice.

• IRS powers of attorney (Form 2848) will be slow to process, so be prepared to use faxes when on hold with the IRS. Incredibly, the IRS still uses fax machines, and because IRS employees will not discuss tax matters with counsel or accountants without receiving a complete, signed Form 2848, expect time lags because it will get even more difficult for anyone to even talk to an IRS employee who can fix a problem. Hold times to wait for the IRS to answer the phone may increase to multiple hours, and often, the IRS phone system may simply hang up. Forms 2848 that have been previously mailed to the IRS are rarely processed, so practitioners should have copies ready to fax to the IRS agent while on a phone call.

• Informal and formal guidance from the IRS on uncertain or complex issues will be delayed. The IRS should not be expected to timely assist on any questions. Historically, informal calls to IRS divisions relating to discrete tax line items on federal tax returns, corporate reorganizations, and exempt organization issues have been helpful in obtaining some comfort on less certain tax positions. Relying on this route is unlikely to bear fruit.

• As stated in the previous article by Robert Romashko, the actual review and approval time for tax-exempt determination letters will extend to beyond the typical 6-8 month period. While there is an ability to request expedited handling, the criteria are extremely narrow and limited to situations such as reliance on a specific grant, or urgent need from major emergencies. Taxpayers should manage expectations when tax-exempt determination requests are submitted. For example, if a taxpayer has related tax-exempt organizations already existing, purchases and donations should continue to be made through the existing tax-exempt entity until the IRS eventually approves the new entity as tax-exempt.

• Obtaining state tax-exempt status will also be difficult, so care should be exercised if substantial property is to be held by a new tax-exempt entity. Because states usually rely upon the federal exemption letter to approve a state exemption, this can cause issues if a new tax-exempt entity is formed and, for example, substantial real estate is expected to be purchased by the new entity and the transaction closed before the IRS tax-exempt determination letter is received.

• Ensure that all correspondence to the IRS is being sent to the correct address. Reports have indicated that various federal properties may be sold and that leases may be discontinued. Restructurings within the IRS may also cause addresses to change. Before sending any correspondence to the IRS, taxpayers should ensure that they have checked the latest IRS addresses on record.

What this means to you

Healthcare organizations and individuals and their professional advisors should manage expectations in the course of their transactions, whenever setting conditions or requirements based on any IRS act or deliverable. These issues impact all sides of an M&A transaction, so parties should work together to agree on mutually beneficial diligence agreements in the light of such an uncertain time.