In the spirit of the season, it’s time to file your taxes. Your tax returns verify your previous income level and are proof of the tax obligations you have fulfilled – both filing and payment. It is recommended to turn to a creditable tax agent to ensure everything is done correctly. For better understanding of your invoice factoring terms of agreement, reach out to your factoring company.
There is a lot to be determined when determining if the receivables you factored are taxable. How a company treats its accounts receivable depends on what accounting method the company takes. If it uses the accrual method, then the company records revenue as soon as it makes a sale, which means accounts receivable get counted as income. The general rule is usually if you sell accounts receivables to a factoring company, your company will report the amount received as income.
How the IRS Analyzes Factored Receivables
Typically, the IRS considers the following:
- Name and location of the factoring company.
- Whether the factoring company is considered a Controlled Foreign Corporation (CFC)
- The relationship between the factoring company and your business
- The nature of the factoring agreement between your business and the factoring company.
- The name of any promoter/advisor or accounting firm involved in structuring the taxpayer’s factoring arrangement.
How you report factoring expenses as deductions on your business tax returns.
Factoring expenses, such as set-up fees and commissions are tax deductible. However, the way you report them is different. based on whether you retain ownership of the receivables or sell them to the factoring company.
When Are Receivables Taxable?
This depends on the ownership of the accounts. When the factoring company owns the receivables, payments towards the outstanding invoices is reported as income. On the other hand, if your business retains ownership of the accounts, payments from the factoring company is not taxable.
Determining if your receivables are subjected to taxation depends on the transaction structure. In some instances, factoring agreements are between two entities like your business and the factoring company. If this is the arrangement, the IRS may not follow all of the steps of the audit. This is most likely because there are transactions structured for state tax purposes and federal tax does not apply.
When Are Not Receivables Not Taxable?
As of 2011, Income earned from factoring accounts receivable are no longer taxable. When you sell invoices to a third-party factoring company, factoring receivables is not part of Subpart F income. The only exception is if the act of factoring receivables does not automatically convert the cash advance into income. The new ruling recognizes that the cash advance your business receives from the factoring agreement is substituted for the income that you would have collected from the invoices. Therefore, you are not required to report the advance.
Which Receivables IRS Auditors Targets
The IRS targets certain accounts receivable arrangements. These get the most attention from auditors.
There are two types of factoring arrangements that get the most attention:
- When the factor or factoring company is outside of the US.
- When the factor is a subsidiary company of the parent company who received the funds.
If the factoring arrangement fees are unaligned with the marketplace, the IRS could also look closely. If you factoring company is based in the U.S. and is a corporate entity you are less likely to be audited. Always consult with a professional tax agent to ensure you are following the required reporting.
About the Author: Factor Finders specializes in finding factoring companies that can fund difficult-to-place deals. Our services help other factoring brokers capitalize on commissions that might otherwise be lost. If you have a prospective transaction that you cannot find a funder then contact us at FactorFinders.com. We’ll find the factor for you and split commissions 50-50.