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Are Factoring Fees Tax Deductible?

To file for tax deductions available from your factoring arrangement, be sure to turn to a reputable and experienced tax preparer. To better understand your factoring agreement, talk with your factoring company professional representative who knows their stuff. Your tax preparer will need to address a few questions and sort out reporting requirements for you.

Are Factoring Fees Tax Deductible

Are Your Factoring Fees Tax-Deductible

Here are a Few Key Questions to Handle:

  1. Is factoring fees tax deductible?
  2. If your factoring agreement calls for invoice sale advance payments to incur interest charges until your customers pay invoices in full, then are the interest charges tax deductible?
  3. How will you choose to deduct your factoring expenses on your tax return?
  4. How are you going to report to the IRS your accounts receivable and the factoring of invoices?
  5. Your tax advisor will determine what, if any, state tax issues you may face. Here, we are only looking at questions about federal taxes for factoring arrangements.  Be sure to get with a tax advisor regarding the applicability of state taxes for your situation. (For example, it may be relevant whether your state has a Gross Receipts Tax, GRT in addition to or rather than a Corporate Income Tax, CIT.)

In addition to a few underlying receivables factoring and tax-related topics in this article, many various bookkeeping and accounting principles may or may not apply correctly to your business. The aim of writing this article is to provide understanding and guidance. Don’t rely on this article without having your tax and accounting experts advise you.

Easy Answers May, or May Not, Be All You Want to Know

The first question has an easy answer. Then again, it also has a more complex follow-up answer. The short answer is yes. Yes, your factoring fees are tax-deductible.

‘How’ to report the factoring fees on your return is more to look at later in this article. How you will deduct your factoring fees on your return will depend on how you have been capturing the costs in your bookkeeping and reflecting them on company financial reports.

Similarly, tax reporting of factoring receivables depends on how you record the receivables in your accounting and company financial reports. We will look more closely at the tax liability of receivables factoring also later in this article.

If that’s all you want to know, then you’ve got a handle on the basics. You will put your trust in the expertise of your bookkeeper, accountant, or tax preparer. They will have to choose your record-keeping methods and IRS reporting options.

Though if this piques your interest, then there is more to uncover that can help you better understand how factoring impacts your company financials and business tax liability. There are a few different choices that you can consider how to report factoring fees and accounts receivable invoices on your business tax return. It may also be helpful to know which certain types of factoring agreements the IRS has been scrutinizing in recent years.

Familiarizing yourself with the tax issues of factoring is a good chance to dig deeper into understanding factoring overall. You will also gain more know-how about how your accountant is interpreting your factoring agreement to track revenue and expenses for your company financial reports.

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Good Advice Online is Tough to Find About Tax Preparation for Factoring 

Clear and specific information about tax issues for factoring agreements is hard to find on the web. We did extensive search engine hunting and also a deep dive at the Internal Revenue Service website. It is clear that nobody has been able to provide a straight-forward and thorough review of this topic before now.

There are a lot of simple answers across the Internet about invoice factoring. Before now, there has been no meaningful explanation for why and how factoring fees are tax-deductible. Nor has there been before now a broader and more in-depth look at other receivables factoring significant picture tax issues. To consider the total cost of ownership of your factoring arrangement, you want as many of the tax issues for invoice factoring laid out for you like just as possible.

IRS Auditors are Targeting Certain Receivables Factoring Arrangements

It is essential to note which kind of factoring agreements have been getting the most attention from the IRS. For at least ten years, the two types of factoring arrangements have a primary focus on IRS:

  • When the “factor” (or the factoring company) is outside of the United States.
  • When the factor turns out to be a subsidiary company of the parent company who received factoring financing.

In these two cases, the IRS is looking for attempts to avoid paying taxes with end-runs around showing the real value of a company’s accounts receivable.

You may notice its mentioned the misuse of transfer pricing when discounting factored invoices in specific factoring arrangements. Such activity being looked at by the IRS is particularly relevant when a factor is a subsidiary of its parent company. This applies to companies both domestically or internationally.

The IRS has also been looking closely at factoring agreements where fees appear to be far off from the usual rates in the marketplace. In other cases, where the percentage of receivables written off as bad debts don’t seem to be the right fit for a company’s overall financial picture.

You can rest easy whether your factoring agreement will attract an audit from the IRS knowing that your factoring company is US-based and is a corporate entity unaffiliated with your company.

Factoring is Not a Loan, But What About That Interest?

One important thing to remember is that factoring is not a loan. Although factoring is used to obtain cash for your business, and it is often referred to as “financing,” it is not a loan. When looking at financing options, you may come across credits that use a company’s accounts receivable as collateral. Don’t confuse that type of a loan with factoring.

What may also trip you up is that, even though factoring is not a loan, your factoring agreement may include an interest rate and terms for interest charges. What’s going on here? When an advance amount is paid to your business toward the discounted purchase price of an invoice, often the interest will be accrued on the advance amount until the customer pays off the invoice in full to the factor. At which time, the factor will then deduct interest charges and any other agreed-upon charges from the remaining (not advanced) amount of the discounted purchase of the invoice. Since interest on a debt is a standard tax deduction, this issue may be relevant for your factoring arrangement.

For one thing, the potential tax-deductibility of the interest on the advance depends on whether your factoring arrangement is recourse financing or non-recourse financing. Usually, factors purchase invoices from clients without recourse (or non-recourse). Meaning, if the factor does not collect the purchased account, due solely to the financial inability of the account debtor to pay, then the factor must still pay its client the agreed purchase price. Whereas in a recourse financing arrangement, if the factor is not paid according to specified terms, then the purchase price of an account is charged back to the client by the factor.

Whether the advance payment of the discounted purchase price of the invoice is considered debt is then determined by whether the factoring arrangement is recourse or non-recourse. If the advance is due back to the factor in case the customer does not pay the invoice (such as in recourse financing), then we can consider the advance as a debt. Whereas if the advance payment is not due back to the factor under most circumstances (such as in non-recourse financing), then the advance is not considered debt because it will likely not be ever charged back to the client.

What matters is that, as a rule of thumb, interest is typically tax-deductible only if the interest is on debt for which the borrower is liable to the lender. Your tax advisor should advise you accordingly.

Factoring Your Receivables Means Accounting for a Few Differences in Bookkeeping and Reporting

Accountants and tax advisors will be the first to tell you that accounting rules for keeping your business books do not jive with IRS rules for reporting taxable income. What that means is that book income can differ from taxable income. When you’re reviewing your company’s expenses and income overall, there will be income and expenses on your tax return not in your books.

Similarly, there are income and expenses on your books not included on your tax return. Crazy, right? Defer to the expertise of your tax preparer to use the proper IRS forms with your return to sort it out. For now, don’t sweat it and move on.

When it comes to your bookkeeping and financial reporting, factoring receivables can be straight-forward in some respects. This also requires specialized attention from your bookkeeper or accountant. An example of the simple truth is that the sale of a receivable to your factor, without recourse, merely lands the receivable on your balance sheet as a sale.

An example of bookkeeping complexity can include tracking what your business owes your factor. Your bookkeeper will maintain your ledger to present a liability on your balance sheet. This will show what you owe your factor at any given point in time. This liability should match the balance on your client statement. At the end of each month, you should reconcile your client balance statement to your accounting system. It would help if you also reconcile your debtors to the debtors’ balance in your accounting system.

To fully understand what it means to factor your invoices is to remember that factoring is an asset-based financing option. As such, factoring is necessarily an advance on the total value of a receivable. This is different from incurring bank financing interest as an expense that impacts your Cost of Goods Sold (COGS) as shown on your income statement.  The impact of factoring on your COGS is that factoring fees are applied against the advance from the factor and not against your product’s COGS.

Depending on your bookkeeper’s chosen accounting methods, another effect of factoring on your COGS may be to dilute the value of your inventory by the price discount of accounts/invoices sold to your factor.

Easy Tax Preparation Starts with Well-Prepared Bookkeeping and Financial Reports

Your accounting system is specifically tailored for your business in combination with the factoring of receivables reflected in your company’s financial reports will guide your tax advisor’s tax reporting decisions. Regarding your factoring arrangement, your tax preparer should:

  • Determine how to categorize the expense of your factoring fees,
  • Present if factoring fees have been netted against items such as sales,
  • Reconcile any factoring deductions that are book/tax differences,
  • Report any cases of securitization of factored accounts receivable,
  • Ensure that factoring reflected in company financial statements are presented uniformly on the tax return,
  • Ensure that all supporting documentation for information on the tax return is complete. Also, it should be on-file as of when the return is filed with the IRS.

Given recent IRS interest in auditing factoring agreements and the nuances of options for tracking and reporting your factoring arrangement, it’s important to turn to a trustworthy and long-standing factoring company. Also, you want to be confident in the advice of the professionals managing your company books and preparing your taxes.

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