Prospective clients are often surprised when a factoring company asks for copies of their tax documents during the application process.
The client’s confusion about this requirement is understandable. After all, why does a company that is financing your invoices need information about your company’s tax returns
Factoring companies request tax information to confirm that your invoices are not affected by tax liens, penalties, or other tax-related issues. In this article, we explain:
- Which tax documents will factoring companies request?
- Why do factoring companies ask for tax documents?
- Why are tax liens a problem?
- How do factoring companies handle tax problems?
1. Which tax documents will factoring companies request?
Factoring companies typically ask for some or all of the following tax documents:
Form 941 shows the factoring company that your company is up to date paying employer-related taxes. While Form 8821 allows factoring companies to receive a copy of previous tax documents.
2. Why do factoring companies ask for tax documents?
Factoring companies need to review your tax information to ensure that your company does not have a tax lien or is at serious risk of getting one. Tax liens affect a factor’s ability to get paid.
In a typical factoring transaction, your company sells its invoices to the factor in exchange for an immediate payment. As part of this process, the factoring company secures its interest in your accounts receivable by filing a UCC lien.
Liens have an order of priority, and the factor’s lien must have first position on your invoices. Otherwise, another lien holder could have the right to collect the payment.
3. Why are tax liens a problem?
Having a tax lien affects your chances of getting financing because tax liens encumber all of your company’s assets. Furthermore, they may have specific priority rules that can allow tax authorities to take a automatic first position against your company’s assets. This situation puts the factoring company’s position in jeopardy.
4. How do factoring companies handle tax problems?
Fortunately, factoring is a common option for companies with tax problems. These companies usually have cash flow problems and are undergoing a turnaround.
Companies with tax problems can use factoring if the following criteria are met.
a) Your company must have a payment plan
Factoring companies will work with your company only if it has a payment plan with the relevant tax authority. Payment plans enable you to repay the tax debt and usually stop enforcement activity.
b) Tax authorities must be willing to subordinate their lien
Tax authorities that have filed a lien against your company will need to subordinate their lien. This subordination enables the factoring company to obtain a first position against your accounts receivable.
A tax authority (e.g., IRS) will consider subordinating its lien position if you can show it is to its advantage. You must prove to the taxing authority that factoring can stabilize your cash flow and help you turn the business around. This argument requires preparation and a viable plan.
c) The factoring company must handle certain tax payments
Most tax authorities that consider subordinating their lien will do so only if the factoring company manages your monthly payments. This strategy provides some assurance to the tax authority that the tax account will remain up to date. Note that this agreement does not relieve you of your tax liability. Instead, the factoring company agrees only to pay tax authorities monthly before paying your company.
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Disclaimer: Tax problems are a serious matter that must be handled promptly and by an expert. Consider retaining a CPA or tax attorney if you need help. This article is not intended as financial or tax advice.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.