Tax Due Diligence Checklist
Small C-Corp Tax Due Diligence Checklist
Tax review items for small, closely-held C-corporations. This checklist focuses on small business C-corps, not public or large multinational structures. The defining issues are E&P tracking, NOL limitations under Section 382, accumulated earnings exposure, and the basis consequences of stock vs. asset deals.
Why a C-Corporation-Specific Checklist
- •C-corps face double taxation, which makes deal structure (asset vs. stock) more consequential than for pass-through entities.
- •NOL carryovers are valuable but limited under Section 382 once ownership changes meaningfully.
- •Accumulated earnings tax and personal holding company tax can apply to closely-held C-corps that retain too much income.
- •Earnings and Profits (E&P) drives the dividend characterization of distributions and is rarely tracked carefully in small C-corps.
The Checklist
Items a buyer or seller in a c-corporation transaction should expect to request, produce, or review.
1. Federal Returns and Schedules
Form 1120 for last 4-6 years with all schedules
Complete returns including Schedule M-1, M-2, M-3 if applicable, Schedule L, and supporting workpapers.
Schedule UTP if filed
Uncertain tax position disclosures.
Form 5471 / 5472 / FBAR for foreign reporting
Any foreign subsidiaries, 25-percent foreign owners, or foreign accounts.
Form 851 / 1122 if part of consolidated group
Affiliated group structure and consolidated return history.
Tax provision workpapers
Current and deferred tax provisions, with supporting memos for any uncertain tax positions.
2. Earnings and Profits (E&P)
E&P drives whether distributions are taxable dividends. Most small C-corps have not tracked E&P with any rigor.
Cumulative E&P schedule
Annual E&P calculations from inception (or from a reasonable starting point), with year-by-year adjustments.
Current vs. accumulated E&P split
By year, with distribution ordering implications.
E&P adjustments not made on the return
Differences from taxable income (e.g., depreciation differences, tax-exempt income, deductions deferred for E&P).
Distribution history with dividend characterization
Each distribution traced through current E&P, accumulated E&P, basis return, and capital gain.
Section 1059 extraordinary dividend tracking
If applicable to corporate shareholders.
3. NOLs and Section 382 Limits
NOL carryovers are valuable, but Section 382 limits how much a buyer can use after an ownership change. The 382 analysis is a critical diligence item for any acquisition of a C-corp with NOLs.
NOL carryover schedule by year of origin
Pre-2018 NOLs (20-year carryforward, 80-percent limit applies post-2017), post-2017 NOLs (indefinite carryforward, 80-percent limit), and any carrybacks taken.
Ownership change history under Section 382
Five-percent shareholder testing and tracking; any prior ownership changes and resulting limitations.
Pre-acquisition Section 382 study
Determination of base limitation amount upon any prior ownership change, RBIG/RBIL analysis, and remaining usable NOLs.
Net unrealized built-in gain or loss at any prior change date
Affects the 5-year recognition period limitation expansion or contraction.
Section 383 and 384 analyses
Limitations on capital loss and credit carryovers, and limits on offsetting acquired entity gains.
Section 269 considerations
Acquisitions whose principal purpose was tax avoidance and the IRS authority to disallow the resulting benefits.
4. Accumulated Earnings and Personal Holding Company
Accumulated earnings tax (AET) exposure
Section 531 imposes a 20-percent tax on earnings retained beyond reasonable business needs. Documentation of business purpose for retained earnings.
Personal holding company (PHC) testing
If 60+ percent of adjusted ordinary gross income is PHC income (passive income, rents, royalties, personal service contracts) and 50+ percent owned by five or fewer individuals, 20-percent PHC tax under Section 541.
Reasonable business needs documentation
Board minutes, business plans, capital expenditure plans, debt obligations, and other support for retained earnings.
Dividend deficiency calculations
If applicable, deficiency dividend procedure under Section 547 to address PHC tax.
5. Stock and Asset Basis
Shareholder stock basis schedule
Each shareholder's basis in their stock, with adjustments for contributions, distributions, and redemptions.
Inside asset basis schedule
Asset-by-asset tax basis, accumulated depreciation, and adjusted basis. Critical for asset sale modeling.
Section 351 / 368 transaction history
Tax-free formations, reorganizations, and any carryover basis from contributed property.
Basis in subsidiaries (for parent companies)
Stock basis in each subsidiary, with consolidated investment account adjustments.
Section 1202 QSBS analysis
Whether stock is qualified small business stock (QSBS): original issuance, gross asset test under $50M at issuance, active business requirement, and holding period.
6. Compensation and Section 280G
Officer and key employee compensation history
By year, including base, bonus, equity, and benefits.
Section 280G golden parachute analysis
Change-of-control payments, base amount calculations, and 20-percent excise tax exposure under Section 4999. Less common but possible in small C-corps with executive comp packages.
Section 162(m) limitations
Generally only applies to public companies, but document any covered employee compensation.
Deferred compensation arrangements (Section 409A)
Plan documents, valuation history, and 409A compliance.
Stock options and equity awards
ISO vs. NQSO history, 422 compliance, and Section 83(b) elections.
7. State and Local Tax
State corporate income, franchise, and CAT returns
All states where the corporation has filed, by year.
State NOL carryovers and any state-specific Section 382 issues
States have varying conformity to federal NOL and 382 rules.
Apportionment factor history
Sales, payroll, property factors by state and year.
Sales and use tax exposure
Wayfair compliance, registrations, and unfiled exposure across states.
Local income, gross receipts, and business taxes
Michigan-specific items if applicable.
8. Specialty and Open Items
Section 163(j) business interest limitation
Computation, carryforward of disallowed interest.
Section 174 R&D capitalization
Identification of R&D expenditures and capitalization compliance since 2022 changes.
Section 41 R&D credit substantiation
If credits claimed, project documentation and qualified research expense allocation.
ERC and other COVID-era credits
Any claims, supporting analysis, IRS correspondence, and indemnification needs.
BEAT and GILTI exposure
Less common in small C-corps but check if foreign affiliates or related-party payments exist.
IRS examinations, notices, appeals, and Tax Court matters
Open and closed for last 6 years.
Statute of limitations status by tax type and year
Open years and any extensions.
9. Worker Classification and Payroll
Form 941, 940, W-2, W-3 for last 4-6 years
Reconciled to general ledger payroll expense.
1099-NEC issuance and contractor classification
Any 1099 workers analyzed under control test or applicable state ABC test.
Independent contractor agreements
Master services agreements, statement of work templates, and any past misclassification audits.
Retirement plan compliance
Form 5500, plan documents, top-heavy and nondiscrimination testing.
Frequently Asked Questions
Why do you focus on small C-corps rather than large or public ones?
Big 4 firms and large law firms cover large and public C-corps in depth. The diligence issues for small, closely-held C-corps are different: less complexity in the tax provision, more risk in things like E&P tracking, accumulated earnings tax, and personal holding company status, and far more sensitivity to NOL limits because the deals are smaller and the NOLs proportionally more valuable. Many small business owners and acquirers do not have access to a tax attorney who works at small-business scale. That gap is the audience for this checklist.
What is a Section 382 ownership change and why does it matter?
Section 382 limits a corporation's ability to use its NOL carryovers after an ownership change. An ownership change generally happens when 5-percent shareholders increase their aggregate ownership by more than 50 percentage points over a three-year period. Buying a C-corp with NOLs almost always triggers an ownership change. The limit is the value of the corporation immediately before the change times a long-term tax-exempt rate. For small C-corps with meaningful NOLs, this limitation can substantially reduce the value of the carryover.
What is the accumulated earnings tax and how do I avoid it?
Section 531 imposes a 20-percent tax on a C-corp's earnings retained beyond the reasonable needs of the business, if accumulation is for the purpose of avoiding shareholder dividend tax. Closely-held C-corps that pile up cash without articulating a clear business purpose are exposed. Documenting business purpose (capex plans, debt obligations, working capital, acquisition reserves) in board minutes and business plans is the standard defense.
Should I structure this deal as an asset purchase or a stock purchase?
For a C-corp seller, an asset sale generally triggers double taxation: the corporation pays tax on the asset gain, and the shareholder then pays tax on the distribution of after-tax proceeds. Stock sales avoid that, which is why C-corp sellers strongly prefer them. Buyers generally prefer asset sales for the basis step-up. The result is usually a negotiated price adjustment to align the parties. The structure decision is usually the single biggest tax issue in the deal.
Are NOLs carried over from before 2018 worth more than newer NOLs?
It depends. Pre-2018 NOLs have a 20-year carryforward but can offset 100 percent of taxable income (subject to Section 382). Post-2017 NOLs have an indefinite carryforward but can only offset 80 percent of taxable income. Pre-2018 NOLs are usually the more flexible asset, but their value depends on whether the corporation will use them within their carryforward window. Both are subject to 382 limits after an ownership change.
Pillar Pages
Sell-Side Tax Due Diligence
For family business owners going to market. Surface and fix tax exposures before a buyer finds them and discounts your price.
Buy-Side Tax Due Diligence
For small businesses growing through acquisition. Understand what you are buying, who carries the exposure, and how to structure the deal.