Your Borrower’s Missing Tax Returns Usually Spell Trouble Published August 22, 2016

Missing Tax ReturnsOur Voluntary Tax System

The U.S. runs under a voluntary tax system. This doesn’t mean “voluntary” in the way that the word “voluntary” is normally used. In fact, it’s quite the opposite. If a taxpayer fails to pay, file, or maintain their IRS tax obligations they can have their assets seized, liens filed, and in high profile cases, incarcerated.

The reality is that paying taxes is not voluntary, the manner in  which people submit their taxes is. In other words, taxpayers are responsible for calculating their tax liabilities and reporting them by way of a tax return. Then they’re responsible for paying the full amount of taxes owing per the returns in order to represent the dollar amount they owe to the IRS.

For commercial lenders, understanding how their borrowers are or are not volunteering their tax information, (i.e., filing tax returns),  could be the difference between a successful or disastrous funding relationship.

Missing Tax Return Psychology

The reasons for failing to file a tax return can range from forgetfulness to fraud. In some cases, a missing return can be an early indication of cash flow issues. Oftentimes, business owners in financial distress, involved in seasonal businesses, or dealing with mismanagement of funds will be forced to face more pressing bills such as payroll, rent, and inventory.

They then take care of that first and ignore the IRS, knowing they cannot ignore those necessities in order to run their business. They can, however, hold off on filing and/or paying their taxes for an extended period of time, even years. For some business owners, the problem escapes their grasp  quickly and in their discouragement, they stop making their tax deposits altogether. The mentality can become “I don’t have the money so I will not file the tax return. Therefore, if I do not file the tax return, the IRS does not know what I owe them, and I beat the system, for now.”

Business owners often think they’ll eventually catch up and pay it off the next quarter or two, unfortunately the catch up may  never come. All too often a small issue with one quarter becomes a year, or several years, of unfiled returns.

To support this behavioral phenomenon, according to a Tax Policy Center behavioral research study, 30% of respondents stated they didn’t file their tax returns timely because there was a balance due on their return.

This is exactly what commercial lenders need to look out for.

The Earliest Warning Sign

Where there is one missing tax return, there is likely another, and many times accompanied by a tax liability. Over the years, we’ve seen the incredible significance of a missing return and its foreshadowing power to predict risk for lenders.

In a recent example, a lender obtained a Tax Guard report which indicated a handful of unfiled tax returns for their client, with no federal tax liens or tax debts to speak of. After working with the client for some time, the returns were eventually filed, triggering an unpaid tax debt of nearly  $650,000! This situation could have been a big problem, but thankfully, the lender was monitoring their client’s tax compliance and with our support, were able to immediately resolve the issues and preserve the funding relationship.

Whether it’s one or twenty missing returns, the ultimate goal is to get to the bottom of the issue and find a resolution quickly. Screening for missing returns is best performed concurrent with monitoring tax deposit compliance. With ongoing tax compliance monitoring, you are alerted to a situation, such as illustrated above, before it endangers your collateral.

A missing tax return is always a red flag for potential risk. Obviously, there can be cases in which a business misses a filing, but they are not necessarily behind on tax deposits. In most situations, not filing a tax return is an initial warning and one that should signal lenders to take a pause and investigate the risks that could be lurking around the corner. Tax Guard can be your Paul Revere!

Have you identified a prospect or customer that has missing tax returns? Would you like to know what this means for you as a lender or better yet, how to solve for it?

Contact us today for a free consultation to discuss your situation and how to protect your funding and customer relationship.

Rich Porterfield
Posted By: Rich Porterfield

Rich has been in the financial/due diligence industry for the past 16 years. His customers have come to rely on him for his deep lending knowledge and methodical approach to solving customer issues. He also has comprehensive understanding of IRS client issues which allows him to provide alternative funding solutions to his customers, increasing their deal sizes and profitability.

When Rich is not on the phone or dazzling a customer, he can be found riding his bicycle, spending time at the beach or walking his dog in Central Park. Originally hailing from San Diego, California, Rich now resides in Manhattan.