Article by Roger Schlueter
Commercial Loan Ramifications of Not Declaring Income in order to Reduce or Eliminate Taxes, is an Ongoing Issue with Small Business. This is especially true with the Sole Proprietorship. The Sole Proprietorship fills out a Profit and Loss Statement as part of the Individuals Personal Tax Return. This is very easily manipulated and often can have the Income Under-reported which in turn makes the Profit Under-reported. This Profit is what is reported on the Income Section of the Personal Tax Return. Under-reporting the Sales and thus the Profit on the Business can reduce Taxes by as much as 30% or more. This can also be done by Increasing Expenses but it is Usually better to not have the Income in the First Place.
Most Banks use a Debt to Income Ratio and a Debt Coverage Ratio as Key Analysis of the Loan Request of the Small Business.
-The Debt to Income Ratio is the amount of Monthly or yearly Debt Divided by the Monthly or Yearly Income. This Ratio is almost always less than 100%. but if the Income is Under-reported then it will rise to amounts that will disqualify the Small Business from getting a Commercial or Personal Loan.
– The Debt Coverage Ratio is measure of how much Profit or Net Income is available to cover the Monthly or Yearly Debt Service. This Ratio is obtained by taking the Monthly or Yearly Cash Flow and dividing it by the Monthly or Yearly Debt Service. This Ratio is almost always over 100% and is expressed as 1 to 1 Ratio. The desired number is approximately 1.25 or 1.30 to 1. The Higher the Better. This Ratio shows the Cash Flow Available to pay Debt Service which must be higher than 1 to 1 in order to pay the Debt over any Period of Time.
This Method of Increasing Profit by not reporting Sales or Increasing Expenses did not mean much to Bankers in the Old Days. The Bank looked at the Business for repayment of the loans and if the business always Paid its Debt and had Cash in the Bank then the Banker did not care (to a point) if the Small Business was Under-reporting or Not. The Point, is that the Business may get audited and Owe a Huge Amount of Taxes that could Jeopardize the Businesses Future Operations. Remember the IRS can just Take Assets and Always gets Paid First if this is an Issue.
The Real Rub is coming to a Head in 2014 because the Regulators are Making the Banks Meet Certain Standards in the Debt to Income Ratios in order to make the loans. If they make loans that do not meet the Standards then the Regulators will say the loan is an Exception to Loan Policy and will Cite the Bank for the Error in Judgement.
The Business that knows it will apply for a Business Loan should always report all income and make as much profit and pay as much taxes ( Taxes that are Owed) as Possible. This will give the bank the Necessary Reasoning to Approve the Loan within the Regulations of its Regulators.