Article: “The Taxes and Bank Loan Quandary: Can a Privately-Held Company Pay Lower Taxes While Showing Profit to Satisfy a Banker?”
It is a common problem for the entrepreneurial business – ownership wants to pay as little as legally possible in taxes, while at the same time banks need to see profitability to satisfy lending criteria. A good accountant can often help management identify and utilize a number of tax breaks. The company is “all smiles” until it goes to the bank and asks for a loan, showing tax returns with little profit or even heavy losses – and is then turned down for the loan. So what can be done to make the banker happy?
There are ways to look good for the bank, both legally and ethically, from tax and accounting standpoints. Yet not all accountants are effective in advising clients of this, which can be very frustrating when outside financing is necessary to fund current and future operations.
According to GAAP
GAAP stands for Generally Accepted Accounting Principles and is a standardized system of definitions, procedures and best practices for the use of accountants in analyzing and reporting the financial status of a company. This reporting is for internal purposes (management) or externally to shareholders, creditors and government regulators. GAAP is used in audits, reviews and compilations of financial statements.
This standardization of accounting definitions and procedures allows for the orderly and efficient communication of financial information. Bankers require a clear and universally accepted set of standards to convey information in order to portray an accurate picture of the financial state of a company, which is then used in loan analysis and ultimately in determining whether funding is available.
The Tax Perspective
Given the GAAP requirements, it may appear that tax returns may need to show roughly the same information. So, for example, if GAAP were to show substantial profits, it might be expected that the tax returns would also be similar. However, there are often ways to simultaneously show lower income for the IRS, legally and without fear of going to jail!
For example, the “book (GAAP) to tax differences” can be explained in the simplest light by looking at tax returns being prepared according to certain allowable standards. These could include a cash basis approach, tax depreciation and net operating loss carryovers. Tax depreciation is an area ripe with opportunities, including Section 179 depreciation, bonus depreciation, and MACRS write-offs. Section 179 of the United States Internal Revenue Code (26 U.S.C. § 179), allows a taxpayer to elect to deduct the cost of certain types of property on their income taxes as an expense, rather than requiring the cost of the property to be capitalized and depreciated. In 2012 bonus depreciation can also be used to write off 50 percent of the cost of equipment, machinery, and computers. Finally, the Modified Accelerated Cost Recovery System (MACRS) is used to recover additional basis of most business and personal property placed in service after 1986. Generally, these three systems provide different methods and recovery periods to use in figuring depreciation deductions. For 2012, $125,000 of fixed assets can qualify for Section 179.
The Role of the CPA Firm
Of course, when a company wants to borrow money, the bank’s lending criteria and loan covenants are key considerations in this entire process. This is where a proactive, knowledgeable CPA firm can make a big difference. By understanding a company’s objectives, the CPA firm can help in structuring and managing opportunities throughout the year in order to best position the company for external financing.
For example, in one of Smith Dickson’s recent new engagements, our accountants assisted the client in preparing GAAP financial statements showing $350,000 of net income. However, through our methods we were able to simultaneously and legitimately produce tax returns with a $100,000 taxable loss. The bottom line from a tax perspective was a refund with no taxes in 2011, zero estimated tax payments required in 2012, and taxes not due until April of 2013. Plus the company was able to obtain its first bank line of credit in the amount of $500,000.
In another situation, a new client came to us with some fairly severe issues affecting their ability to obtain outside financing. Their underlying records were grossly wrong: annual losses were shown for several years, current year accounts payable were off by $1.2 million, accounts receivable were incorrect by $800,000 and retained earnings were misstated by $1 million. Our accountants supervised the client in adjusting up the records and prepared compiled financial statements. The client was then able to show $9 million in revenue, $280,000 in profit, and a positive net worth of $800,000. With our guidance and assistance, the company was then able to obtain a $650,000 working capital line of credit from a highly reputable bank, which it had never had before.
Presenting favorable, accurate, and well-documented financial statements make your banker comfortable. Simultaneously preparing tax returns in which the tax liability is not as heavy can be possible. We recommend that your company take advantage of all financial statement and tax return planning opportunities that are available.
Smith Dickson offers specialized expertise in obtaining or renewing bank lines of credit or loans. For companies who have difficulty obtaining traditional bank financing, we are often able to help turn their situation around. If you have an questions or require such assistance, feel free to contact us.