5 Risky Underwriting Habits and the Best Ways to Correct Them Published February 17, 2017
Gaps in solid underwriting can be the difference between a successful lending relationship and one that ends up in default. Here are a few we’ve identified to help you identify hidden risk and minimize your exposure:
1. Assuming a federal tax lien will be filed if a tax debt exists.
The IRS does not always file a tax lien. An unpaid tax debt may exist but you will not always learn this information from a traditional public records search. According to the U.S. Government Accountability Office, only 40% of all unpaid payroll tax liabilities currently in the IRS’ inventory have a tax lien filed against them.
You still may be at risk even if the public filing of a federal tax lien hasn’t been recorded. What’s known as a “silent lien” can have a big impact on your collateral, putting you at risk because the IRS does not need to file a lien in order to begin seizing assets such as bank accounts and accounts receivable.
Make sure you’re effectively searching for federal tax debts, not just federal tax liens.
2. Lack of understanding about the 45-day rule and potential ramifications for commercial lending.
If an IRS tax lien is filed and a lender funds after 45 days from the date of the IRS tax lien, the lender will be in second position behind the IRS. In summary, IRC sections 6323(c) and (d) grant lenders priority over the federal tax lien to the extent the loan or purchase is made (a) within 45 days of the filing of the notice of federal tax lien or (b) before the lender had actual knowledge of the filing, whichever comes first (45 days from filing or actual knowledge).
For a more detailed understanding of the 45-day rule and how to mitigate your risk, view our informative video that breaks down the basic elements of the rule and explains how to protect your business as a lender, IRS 45-Day Rule Overview Video.
3. Funding a business without understanding their percentage of ownership and/or additional ownership in other businesses.
Utilizing the IRS Wage and Income information (Schedule K-1, Form W-2, Form 5498 series, Forms 1098 and 1099 series), allows you to identify shareholder details as well as the percentage of ownership, ordinary income, capital gains, interests, etc.
By understanding what additional businesses a borrower may have a financial connection to, allows you to further investigate and determine if you have additional exposure.
4. Only reviewing the last three years of a borrower’s tax compliance history.
A three-year history is only scratching the surface. A full 50% of all federal tax debt is older than five years, so requiring or reviewing only three years of tax information for funding approval means you could miss uncovering additional tax debts from prior years.
Given that the IRS’s ability to collect tax debt is determined by a statute of limitations, which is generally ten years from the date of assessment, it is important to know that going back more than three years is critical when determining your borrower’s creditworthiness. Tax Guard recommends you review up to ten years to ensure you have a full picture.
5. Relying on customers to either provide access to tax returns, bank accounts, provide bank statements and/or canceled checks, or to verify quarterly 941 deposits.
The information provided from your borrowers may not match what the IRS or bank has on record for their business. For example, a borrower can easily complete a tax return form with fictitious business income figures, and never file that return with the IRS. Or they could file the tax return but provide you with an altered copy.
Verifying data directly from the source in addition to obtaining the records from your borrowers is the only way to ensure you are not being subjected to fraudulent income or expense data.
By tightening up the process around these key underwriting processes, you’ll be able to protect yourself from fraudulent information and help prevent future loss. To learn how Tax Guard reports can help you prevent these issues, contact us today.