Archive by Author

Dec 15

Igi-108269107-733x358magine this scenario — Jane just received a CP508C notice informing her that her passport is being revoked. Unfortunately, it’s bad timing for Jane as she is about to travel overseas for business. She doesn’t know what to do and reaches out to her CPA for help.

Jane’s CPA explains that the IRS notified the U.S. State Department of her seriously delinquent federal tax debt (SDTD) and as a result is revoking her current passport. Jane has limited options. She needs to request an installment agreement or pay off the tax debt (both are a struggle for her as she needs to travel overseas to earn income to pay her debts).

She ends up finding a way to pay the IRS in full at which point her CPA notifies the local Taxpayer Advocate Service (TAS) office to help expedite the passport decertification process. She receives CP508R notifying her that the certification of tax debt was reversed. Only with the diligent help of her CPA and the TAS is Jane able to get her passport reinstated, just in time for her travel plans.

Could this scenario be a common occurrence for your clients soon?

Background

On Dec. 4., 2015, the Fixing America’s Surface Transportation Act (FAST Act) was enacted and included Sec. 7345, Revocation or denial of passport in case of certain tax delinquencies, allowing the IRS to notify the Secretary of State to deny, revoke or limit a U.S. passport upon certification of an SDTD.

An SDTD is defined as “an unpaid, legally enforceable federal tax liability of an individual” which has been assessed, is more than $50,000 indexed for inflation (current threshold is $51,000), and for which a lien has been filed under Sec. 6323, Validity and priority against certain persons. Also, the administrative Collection Due Process (CDP) rights under Sec. 6320, Notice and opportunity for hearing upon filing of notice of lien, have been exhausted or lapsed or a levy has been made under Sec. 6331, Levy and distraint. Note that the tax liability includes the actual tax plus assessed penalties and interest.

Simply put, if an individual taxpayer currently owes more than $51,000, a federal tax lien was filed against the taxpayer for all the tax periods covering the federal tax liability, CDP rights have been exhausted and a levy has been issued, then the individual could be subject to passport revocation. Submitting a payment to bring the liability under the $51,000 threshold after an individual has been certified will not reverse the notification of certification.

The process

There are many facets to the passport revocation process. Here are some considerations and details to keep in mind:

IRM 5.19.1.5.19.2 (12-26-2017) states that an SDTD includes tax assessments made under an individual’s Social Security number (SSN) or federal employer identification number (FEIN) including U.S. individual income taxes, trust fund recovery penalties, business taxes for which the individual taxpayer is liable and other civil penalties. Assessments, including FBAR penalties assessed under Title 31 of the Bank Secrecy Act and other non-tax liabilities outside the scope of the IRS, do not constitute an SDTD. The $50,000 threshold does not include accrued interest and penalty (IRM 51.12.27.2 (12-20-2017)).
The statutory exceptions to passport revocation or denial include a tax debt being paid in a timely manner under Sec. 6159, Agreements for payment of tax liability in installments, or Sec. 7122, Compromises, a debt where collection is suspended due to a requested or pending CDP hearing or a request for relief under the innocent spouse rules of Sec. 6015, Relief from joint and several liability on joint returns. Other statutory exclusions are detailed in IRM 5.1.12.27.3 (12-20-2017).
The IRS also has the discretion to exclude categories of tax debt from certification (IRM 5.1.12.27.4 (12-20-17) and 5.19.1.5.19.4 (12-26-17)), even if the debt meets the criteria of an SDTD. Some of these include debt deemed uncollectible due to hardship, debt resulting from identity theft or taxpayers in a disaster zone.
The IRS is required to notify the taxpayer, in writing, at the time the certification of an SDTD is made to the State Department (IRM 5.1.12.27.7 (12-20-17)).
Often, taxpayers’ representatives with a valid power of attorney are not receiving the CP508C or CP508R notices. Taxpayers’ representatives must remember to ask clients with liabilities over $51,000 to forward all notices to them including the CP508C and CP508R.
The IRS can reverse the certification of an SDTD as outlined in IRM 5.1.12.27.8 (12-20-17).
There is no administrative appeal process for certification of a taxpayer’s account. Taxpayers whose accounts are certified to the State Department as an SDTD can file suit in U.S. Tax Court or a District Court of the U.S. If the court determines the certification is erroneous or should have been reversed, it can order the certification reversal (IRM 5.1.12.27.9 (12-20-2017)).

Pushback

The 2017 National Taxpayer Advocate Annual Report to Congress included a section on passport denial and revocation that provided criticisms of the process and detailed the taxpayer rights that have been severely and negatively impacted.

The report stated that the TAS provided the IRS with constructive comments on Notice CP508C. First, the notice only provides two options for the taxpayer to preclude the State Department from denying, revoking or limiting the passport: payment of the debt in full or the alternate payment arrangements described above. Second, the notice does not refer to scenarios where the taxpayer may be a victim of identity theft or qualifies for uncollectible status.

Nina E. Olson, the National Taxpayer Advocate (NTA), has written several articles for the TAS NTA blog about the IRS’s passport program which includes a focus on the IRS’s refusal to exclude open TAS cases from passport certification.

There are systemic issues associated with the passport revocation program. Examples include an instance when the tax liability was paid in full and the taxpayer received a CP508C notice one month after the liability was paid in full. In another case, the taxpayer had an existing installment agreement, yet the taxpayer received a CP508C notice. In both cases, the TAS was contacted and assisted in resolving the case.

What CPAs can do

Practitioners and their clients should be proactive in attempting to resolve unpaid tax liability issues. Ask your clients with outstanding tax issues how they would like to resolve the issue. A few of the alternatives include an installment agreement, offer in compromise, full payment of the liability or request for uncollectible status due to financial hardship.

Remember, a pending installment agreement request will stop the CP508C letter from being issued. Use this request for an installment agreement template as a guide.

Do not let your clients lose their CDP rights. File a Form 12153, Request for a Collection Due Process or Equivalent Hearing, in response to Notice 3172 and/or Notice 1058 and try to resolve the issue through CDP. Remember CP508C letters can be issued if the accumulated liability exceeds $51,000 and all administrative remedies such as CDP have been exhausted. Look at the IRS Collection Appeal Options Quick Reference Chart to help you navigate the hurdles.

The process of decertification does work. In a recent case, a husband and wife each received notice of certification (CP508C) on Aug. 20, 2018. The husband and wife’s outstanding tax liability was placed in uncollectible status due to financial hardship through a Revenue Office and notice CP508R was issued on Oct. 22, 2018.

In another case where the taxpayer owed over $300,000, the taxpayer was able to enter into an installment agreement of $100 per month and within two months received notice CP508R.

Always work and attempt to resolve cases at the lowest possible level. Make sure that all unfiled tax returns have been filed and, if needed, an estimated tax payment submitted for the current year. Also, have the appropriate collection information statement (Forms 433-A or 433-F) complete and ready to go, should you need to justify your client’s financial situation. Consider contacting your local TAS office to assist with decertification.

Passport revocations are becoming more frequent as the IRS cracks down on SDTD. If your client finds out he or she is subject to a passport revocation for failure to pay the IRS, there are many avenues of assistance available to get them back on track.

Jul 25

State Minimum Wage
Alabama $7.25 (Federal, no state minimum)
Alaska $9.84
Arizona $10.50
Arkansas $8.50
California $11.00*
Colorado $10.20
Connecticut $10.10
Delaware $8.25
Washington D.C. $12.50 (set to increase on 7/1/18 to $13.25)
Florida $8.25
Georgia $5.15 (Employers subject to Fair Labor Standards Act must pay the federal minimum wage.)
Hawaii $10.10
Idaho $7.25
Illinois $8.25
Indiana $7.25
Iowa $7.25
Kansas $7.25
Kentucky $7.25
Louisiana $7.25 (Federal, no state minimum)
Maine $10.00
Maryland $9.25
Massachusetts $11.00
Michigan $9.25
Minnesota $9.65**
Mississippi $7.25 (Federal, no state minimum)
Missouri $7.85
Montana $8.30
Nebraska $9.00
Nevada $8.25
New Hampshire $7.25 (Federal, no state minimum)
New Jersey $8.60
New Mexico $7.50
New York $10.40
North Carolina $7.25
North Dakota $7.25
Ohio $8.30
Oklahoma $7.25
Oregon $10.25
Pennsylvania $7.25
Rhode Island $10.10
South Carolina $7.25 (Federal, no state minimum)
South Dakota $8.65
Tennessee $7.25 (Federal, no state minimum)
Texas $7.25
Utah $7.25
Vermont $10.50
Virginia $7.25
Washington $11.50
West Virginia $8.75
Wisconsin $7.25
Wyoming $5.15 (Employers subject to Fair Labor Standards Act must pay the federal minimum wage.)

Apr 17

Tuesday afternoon, the agency couldmn’t accept information transmitted from tax software providers. (Taxpayers won’t be penalized) But that’s not the biggest of the IRS’s problems. If a bill to retool it gains steam, the agency- already crippled by years of budget cuts,vulnerable to fraud and reliant on antiquated technology- could face restructuring just as it faces major changes to the tax code.Fix it!539w

Dec 17

Congressional leaders unveiled a wide-ranging deal on tax extenders, making some items permanent.

The Protecting Americans from Tax Hikes Act of 2015 is a culmination of recent work done in both chambers of Congress and renews and makes permanent important tax incentives that support both individuals and job creators. Among the provisions that would be made permanent are the enhanced Child Tax Credit, the enhanced American Opportunity Tax Credit, the enhanced Earned Income Tax Credit, the above-the-line deduction for teachers who buy school supplies, the charitable deduction of contributions of real property for conservation purposes, along with the Research & Development Tax Credit and Section 179 expensing.

The permanent R&D Tax Credit provision permanently extends the research & development tax credit and, for the first time, allows for eligible small businesses to claim the credit against the alternative minimum tax liability or against the employer’s payroll tax liability. The Section 179 provision permanently extends the small business expensing limitation and phase-out amounts in effect from 2010 to 2014; and sets a new threshold at $500,000 and $2 million, respectively, from the current amounts of $25,000 and $200,000, respectively.

In addition, the legislation suspends the 2.3 percent excise tax on medical devices through 2017 and delays for two years the so-called “Cadillac tax” on high-priced health insurance plans that was supposed to begin in 2018. It also phases out bonus depreciation. Another provision permanently extends the exception from subpart F income for active financing income. The legislation also permanently extends the rule reducing to five years (rather than 10 years) the period for which an S corporation must hold its assets following conversion from a C corporation to avoid the tax on built-in gains.

Another provision permanently extends the ability of individuals at least 70½ years of age to exclude from gross income qualified charitable distributions from Individual Retirement Accounts (IRAs) of up to $100,000 per taxpayer in any tax year.

Congress is expected to vote by the end of the week on the tax legislation along with an omnibus spending bill that was also unveiled late Tuesday night (see Congress Reaches Deal on Tax Extenders).

“Santa came early this year with gifts for almost everyone in the form of numerous tax relief provisions, although the IRS may view its gift as a lump of coal,” said Peter Mills, managing editor of federal taxes for Bloomberg BNA. “Tax planners would gain more certainty because the bill would make permanent many important tax provisions, most notably the research and development credit, the expanded §179 expensing limitations, the enhanced child tax credit, and the earned income tax credit, as well as extending some popular temporary provisions, such as bonus depreciation. Foreign investors would gain advantages in increasing investment in U.S. real estate by increasing their ownership percentage of publicly traded REITs without being taxed on sales of the interests, and by exempting foreign retirement and pension funds from being taxed on sales of REITS holding U.S. real estate. It also would delay some of the taxes associated with the Affordable Care Act. The IRS fares less well under the bill with new restrictions, including a rule providing for the termination of any IRS employee who takes official actions for political purposes. Moreover, the IRS has the burden of processing these changes in time for the upcoming tax season.”

The Internal Revenue Service would receive $11.23 billion in fiscal year 2016, an increase of $290 million over the current level, specifically for customer service, identity theft and cybersecurity, according to the National Treasury Employees Union. While that figure is $1.7 billion less than the administration’s request of $12.9 billion, the NTWU noted, the final amount is an improvement over the House proposal to cut the IRS budget by almost $838 million compared to the current level.

The bill would make permanent a provision that allows retailers to depreciate remodeling and other improvements to their stores over 15 years rather than the previous standard of 39 years, the National Retail Federation pointed out. The provision, which also applies to restaurants, is important because retailers typically remodel every five to seven years. In addition to helping keep stores attractive to customers and profitable, the remodeling work creates tens of thousands of construction jobs each year.

A separate provision that allows 50 percent of the cost of improvements to be written off under “bonus deprecation” would be extended for five years, and would be expanded to cover stores and restaurants that are owned rather than just those that are leased.

Section 179 expensing, which determines the amount of an investment a small business is allowed to write off entirely in the first year rather than being depreciated over multiple years, would be made permanent and its level would be increased.

The Work Opportunity Tax Credit, which gives retailers a tax incentive to hire the disabled, welfare recipients and other economically challenged individuals, would be renewed for five years.

Paul Gevertzman, a tax partner at Anchin, Block & Anchin, sees benefits in having more certainty about the tax provisions. “The most positive aspect of this extender package is that many of the perennially expiring provisions are either made permanent, or at least pushed off beyond another New Year’s morning expiration,” he said. “What it means for businesses is that they can now plan properly. They can operate with the knowledge that if they follow the prescribed steps they can achieve the anticipated tax result. I had one client tell me just this morning how he’s been sweating it out because they spent $20+ million dollars on equipment purchases in 2015 not knowing for certain how much of that spend could be written off this year. This bill takes the guesswork out of the equation. This certainty allows tax incentives to actually incentivize businesses to spend, rather than to simply provide a benefit to businesses post facto for what they’ve already done.”

Speaker of the House Paul Ryan, R-Wis., spoke of the advantages of the tax deal during a press briefing Wednesday. “I cannot tell you how many times I have visited with small businesses and farmers who tell me, ‘Give me some certainty in the tax code, and I can go create jobs.’ We are finally delivering on one of those tax policies we’ve been trying to—for years—to get certainty in the tax code so we can create more jobs,” he said. “I think this is one of the biggest steps toward a re-write of our tax code that we’ve made in many years. And it will help us start a pro-growth, bold tax reform agenda in 2016.”

The Senate Finance and House Ways and Means Committees have worked on efforts in Congress to overhaul the tax code through working groups, hearings, roundtables, issue papers and markups.

“Passing this legislation and making more tax policies permanent will provide significant tax relief for hard-working taxpayers in every walk of American life, from the middle class to military families to the working poor,” said Senate Finance Committee chairman Orrin Hatch, R-Utah, in a speech on the Senate floor Wednesday. “It will do the same for businesses and job creators throughout our country, resulting in a healthier U.S. economy, increased growth, and more American jobs,” Hatch said. “Put simply, more permanence in the tax code will be a good thing for our country, and the PATH Act will provide just the kind of permanence we need.”

Earlier this year, the Senate Finance Committee reported out a bipartisan tax extenders package that extended provisions to help families, individuals and small businesses for two years. The House Ways and Means Committee advanced several tax bills that would make permanent a number of policies, like incentives for innovative research and development, among others.

The PATH Act includes a number of bipartisan legislative policies that were advanced by the two tax-writing committees.

“It makes absolutely no sense the way America handles its tax code,” said House Ways and Means Committee chairman Kevin Brady, R-Texas, in a statement. “How can families and local businesses count on tax relief each year as long as Congress can’t decide what’s permanent and what’s not? That confusion ends now, and our economy will be stronger for it.”

However, the bill will come at a cost of billions of dollars added to annual budget deficit, which may complicate passage in Congress.

“This bill highlights clear priorities for reforming our tax system,” said Wyden. “What does that mean?  Millions of working families with children will not find themselves suddenly taxed into poverty. Millions of college students won’t have the rug pulled out from under them when the tuition bill arrives. Charities can confidently plan and expand the good work they do. And small business and enterprises on the forefront of innovation now have the economic certainty they deserve. At the same time we are phasing out provisions like bonus depreciation which were always designed to be temporary. But now is not the time for Congress to slow down and pat itself on the back. Today is a down payment on tax reform and our work continues as we strive towards a complete overhaul of our broken tax system.”

The tax extenders package also includes a five-year extension of the wind energy production tax credit to lead to a phase-down of the industry-specific tax credit. The wind production tax credit will be 100 percent in 2015 and 2016, 80 percent in 2017, 60 percent in 2018 and 40 percent in 2019.

Sen. Chuck Grassley, R-Iowa, had advocated for passage of this provision. “As the father of the first wind energy tax credit in 1992, I can say that the tax credit was never meant to be permanent,” Grassley said in a statement. “I also can say that the wind energy industry is the only energy industry that came forward with a phase-out plan. The oil and nuclear industries have benefited from tax incentives that have been permanently on the books for decades.  The five-year extension for wind energy brings about the best possible long-term outcome that provides certainty, predictability and a responsible phase-down of a tax incentive for a renewable energy source.”

The tax package includes an extension of the existing biodiesel fuel blenders credit, the small agri-biodiesel producer credit, the tax credit for cellulosic biofuels producers, the alternative fuel vehicle refueling tax credit, and bonus depreciation for cellulosic biofuel facilities.

Jul 31

highway

The short-term highway funding extension passed by the Senate on Thursday contains several important tax
provisions. The bill modifies the due dates for several common tax returns, overrules the
Supreme Court’s Home Concrete decision, requires that additional information be reported on mortgage
information statements, and requires consistent basis reporting between estates and beneficiaries.

         

Due date modifications

For partnership returns -  the new due date is March 15 (for calendar-year partnerships) and the 15th day of the
third month following the close of the fiscal year (for fiscal-year partnerships).

For C corporations – the new due date is the 15th day of the fourth month following the close of the
corporation’s year.

The new due dates will apply to returns for tax years beginning after Dec. 31, 2015. However, for C
corporations with fiscal years ending on June 30, the new due dates will not apply until tax years beginning
after Dec. 31, 2025.

taxes-646511_640

Oct 01

Regulations issued on Tuesday finalize rules the IRS put into effect in 2012 allowing employees to deduct certain expenses paid or incurred for local lodging as business expenses.
Normally, lodging expenses a taxpayer incurs while not traveling away from home are considered personal expenses under Sec. 262(a) and are not deductible. However, under the new rules, local lodging expenses that meet certain criteria will be considered ordinary and necessary business expenses and therefore deductible under Sec. 162.
To be deductible, local lodging expenses must meet a facts-and-circumstances test under Regs. Sec. 1.162-32(a) or qualify for a safe harbor under Regs. Sec. 1.162-32(b). Local lodging expenses paid by an employer on behalf of an employee may be deductible under Sec. 132 as a working condition fringe benefit if they meet the new tests. If an employee is reimbursed by the employer for local lodging expenses, the reimbursement amount may be excludable from the employee’s income if the expense allowance arrangement qualifies as an accountable plan under Sec. 62(c).
One factor considered under the facts-and-circumstances test is whether the expense is a “bona fide condition or requirement of employment imposed by the taxpayer’s employer.” Examples given in the regulations to illustrate the facts-and-circumstances test include employees who are required to stay at a local hotel during a work-related training session; professional athletes who are required to stay at a local hotel before a home game; an employee who is relocating for work and looking for a new home; an employee who has to stay at a hotel near the office while working long hours; and employees who occasionally are on call for a night duty shift and stay at a local hotel.
Under the safe harbor, local lodging expenses will be treated as an ordinary and necessary business expense if:
· The lodging is necessary for the employee to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function;
· The lodging does not exceed five calendar days and does not occur more than once each calendar quarter;
· The employer requires the employee to remain at the activity or function overnight; and
· The lodging is not extravagant or lavish and does not provide a significant element of personal pleasure.
The final regulations clarify that expenses that do not qualify for the Regs. Sec. 1.162-32(b) safe harbor may nevertheless be deductible under the facts-and-circumstances test.
Taxpayers may apply the new rules to any tax year that is still open.

Sep 15

The GAO says that since FY 2010, the IRS has lost 10,000 employees and had its budget cut by $900 million. More cuts are proposed for the 2015 IRS budget. Identity theft issues, foreign asset reporting, and Affordable Care Act (ACA) responsibilities will continue to absorb personnel and resources. This budget reality will hamper IRS audit goals, but there are still many audit targets that you will want to discuss with your business clients in the next few months.

The rich and their entities. High-income taxpayers will continue to receive audit attention (at about a 9% rate for those reporting income of $1 million to $5 million). Since these taxpayers often have complex tax returns with income and losses from many flow-through entities, the audit of the owner will often lead to an expansion of the IRS examination into the various entities.

Partnership returns. Partnerships are the fastest-growing segment of all tax returns filed. The IRS hopes to expand its audits of partnership and LLC returns. Flow-through losses from developers and real estate investors will get special attention. The audit rate of partnerships and LLCs was a dismal .42% for FY 2013. The IRS did special training this year to increase the number of auditors with a specialized knowledge in partnership law.

Employment taxes. Employment taxes are a focus this year, and this includes a continuing look by the IRS at:
1. Employee versus independent contractor,
2. Form 1099 compliance, and
3. S corporation reasonable compensation issues.
Remember that when the ACA’s employer mandate takes effect in 2015 and 2016, the employee versus independent contractor determination will become more important. Employer ACA penalties can be up to $3,000 for each misclassified employee.

Cash businesses. The tax gap remains a hot item, so cash-intensive businesses will receive a little more attention from the IRS. The IRS is using Form 1099-K to help it select some of these businesses for audit.

Dec 11

Unknown

Nov 29

IRSTargetsThousandsOf Small BusinessesForExtraScrutiny – In 3 Parts

 

Part I – What the IRS is doing.

 The IRS has always been able to match individual tax returns against information statements and propose under reporter adjustments that come in the form of CP2000 notices. ?? But things are changing, and a new era at the IRS is upon us. ?? Now, the IRS is using information statements to find under reporting on business returns.

 

Thetaxagencyisdoingsome targetingofitsown,fingeringatleast 20,000smallbusinesses. Andthatnumber willgrow. Thescrutinyonthisgroupandinthisway isalittlefrightening.   Smallbusinesspeople acrossAmericaarereceivingIRSnotices. Morewillbecoming.TheIRSgathersdata frommanythirdparties-including credit cardcompanies-toseeif youpickedup everynickelofincome. Remembertorecordandpay

tax on all transactions?

 

In September, the IRS started its first information return-matching program for business return Forms 1120, 1120S and 1065. This program matched business return incomes to the total amounts reported on all information returns. ??  That would include merchant reporting of credit cards and third party network payments and cash reporting.

 

This year, business taxpayers also started receiving Form 1099-K, Merchant Card and Third-party Network Payments, reporting amounts received from payment settlement entities (from debit/credit cards and third-party network payers such as PayPal). To avoid taxpayer burden, the IRS stated in a letter to the National Federation of Independent Business on Feb. 9 that it will not require taxpayers to separately report amounts from Forms 1099-K on returns, and has no plans to in the future. ??

 

Wait a minute; not everyone is convinced. One Congressman, Sam Graves (R­ Mo), Chairman of the House Committee on Small Business, notes that the IRS’s first sentence begins, “Your gross receipts may have been underreported.” Says Congressman Graves that sounds like the IRS is looking for more than just additionalinformation. It soundslikeitcouldmeanmoretaxes,penalties andinterest,Sam Graves wroteinthislettertothe agency.

Mr.Gravessuggeststhattheletterscouldintimidate businesses.Hesaysthatasmallbusinessowner receivingthisnoticemaybealarmedandfeel threatened. TheIRSnoticegoesontosayyour receiptsareofffromanIRSaverage. Within30 days,pleaseprovidedocumentationtoprovewhy yournumbersdon’tfallwithinIRS’sstandard,the IRSasks.

 

YettheIRSdoesn’trevealitssourceanddoesn’tsay

whatthestandardisorwhereitcamefrom. It soundslikeyouarebeingaskedtoprovethat youdidn’tunderreportyourincome. That’s provinganegative,andcouldrequireextensive correspondenceanddocumentation.

 

AsaresultofForm1099changesandtheever-increasingwebofreporting,theIRSreceives detaileddataaboutcredit-anddebit-card transactions. TheIRSminesthedataandmaythink thatahighpercentageofcardtransactionsmay meanyouarenotreportingall thecashyoureceive.

 

‘Pleaseexplain,’theIRSmayask. – go to Part II

Jul 29

As simple as it may sound, the ex- act required down payment for a U.S. Small Business Administration (SBA) loan is often a source of confusion for commercial mortgage brokers, borrowers and lenders alike. The reasons vary, but many industry professionals have long relied on hearsay when it comes to the required amount of down payment for SBA requests. Commercial mortgage brokers must keep themselves informed about the guidance provided by the SBA regarding the required down payment for each of its programs — the SBA 7(a) and SBA 504, in particular — as well as relevant industry practices.

A frequent source of confusion stems from the SBA 7(a) program’s requirements regarding borrower down payment versus lenders’ requirements. Although SBA has oversight on credit and eligibility decisions on 7(a) loan requests, lenders often have their own credit criteria geared toward SBA lending. As a result, lenders may decline a loan request for any number of reasons that may not necessarily be related to SBA requirements.

SBA 7(a)

When it comes to the required borrower down payment on 7(a) loans, it is beneficial to know what SBA exactly mandates. According to a document titled “Lender and Development Company Loan Programs” published by the SBA in 2009, “The lender must determine if the equity and the pro forma debt-to-worth are acceptable based on the factors related to that type of business, experience of the management and the level of competition in the market area.”

“The lender must include in its credit analysis a detailed discussion of the required equity and its adequacy,” it adds.

With this in mind, it is clear that lenders rather than the SBA are usually the actual decision makers on the amount of required equity. The SBA typically will raise questions if the amount seems light given the industry or nature of the transaction, but often lenders’ down payment requirements are what borrowers have to meet.

Many lenders typically will require a 10 percent down payment on the purchase of fixed assets. They also will ask for more than 10 percent to be injected if the request is made by a startup or for business acquisition, which reflects prudent lending standards because the risk profile of these requests is higher, meaning that more equity is required to mitigate that risk.

Closing costs

Commercial mortgage brokers also should advise their clients about the possibility of rolling the closing costs into the total loan amount, which may not be the case with conventional loans. For example, if a property is purchased at $1 million and the closing costs are $30,000, many lenders will allow these costs to be financed along with the purchase price. In this case, if a borrower provides a 10 percent down payment on a fixed-asset purchase of $1 million, the loan amount will be $930,000 and the total out-of-pocket equity down payment from the borrower will be $100,000.

In addition, remember that lenders typically consider the totality of the request (credit scores, historical repayment ability, collateral, management experience, etc.) in determining their comfort level with the down payment amount that borrowers are required to inject. As a result, lenders’ decisions can vary and a decline by one lender does not mean necessarily that the request is not suitable for SBA approval. Similarly, lenders may vary in their down payment requirements.

SBA 504

The SBA 504 program is more direct regarding required down payments. This program typically provides as much as 90 percent funding — a conventional first mortgage equaling 50 percent of the total project, and a below-market, 10-year or 20-year fixed-rate second mortgage for as much as 40 percent of the project provided by an SBA certified development company (CDC). The borrowers’ down payment will be about 10 percent to 20 percent.

In the 504 program, which can be used only to purchase fixed assets such as commercial real estate or equipment, the SBA requires that borrowers inject 10 percent as a down payment on the total project inclusive of closing and soft costs. If the business is a startup, an additional 5 percent is required, increasing the down payment to a minimum of 15 percent. If the business is for the purchase of a special-use facility (ice-hockey rink, hotel, car wash, etc.), an additional 5 percent also  is required.

When an additional 5 percent equity down payment is required, the amount typically reduces the second mortgage. For example, if the loan request is for a $1 million startup car wash, the bank makes a 50 percent first mortgage, SBA funding provides a 30 percent second mortgage and the borrower injects $200,000 as a down payment.

The SBA provides CDCs with some latitude in determining whether a business is considered a startup. Many CDCs will consider the business a startup only if it has been operating for two years or less, however. Finally, commercial mortgage brokers should know that payments made upfront by borrowers toward soft and closing costs — if documented — can be counted toward equity requirements if these were explicitly used for the project being submitted to the SBA.

***

Commercial mortgage brokers should look for new ways to help their clients and clarify the areas in the loan process that can be sources of confusion. Kruse and Crawford can provide advice on down payment requirements and assist in determining the right loan source for your business funding.

As published in Scotsman Guide’s Commercial Edition, July 2013. By Jim Noone

Jim Noone is vice president at Prudent Lenders. Prudent Lenders provides U.S. Small Business Administration 7(a) loan processing, closing and portfolio servicing to community banks across the country with speed and efficiency and the added peace of mind that it has been “done right.” http://prudentlenders.com/  Reach Jim Noone at (610) 768-7792 and jnoone@prudentlenders.com.