Tax Considerations regarding business credit
Tax policies must be put into consideration when planning on the mode of business financing, since tax policies influences the capital structure decisions taken by the company. For instance the percentage of money generated from the ploughing back of profits or the release of certain class of securities. Tax considerations in regard to business credit are subject to various restrictions and regulations by the Internal Revenue Service (IRS). Taxes have various implications on a business processes and thus in order to cut down on the tax burden imposed on the business, critical decisions must be made about the financing policy taken by the firm.
Business credits if well planned can bring significant tax benefits to the firm. The principal and interest paid on the credit facility are classified as business expenses, and thus are deductible from the taxable income. In order to qualify for a tax deduction, the firm should be able to ascertain the amount of credit taken, and the assets and expenses financed must have been acquired for use in the business’s operation.
Majority of the business credits are not regarded as a source of business income. For instance when a firm negotiates with a lender or creditor to reduce its debt or write off the loan, the firm will accrue taxes on the amount forgiven or written off. In case where a business issues credit and the debtors defaults the loan, the firm can claim tax deductions on the amounts forgiven or written off against the taxable amount. However if the amounts are recovered later in the future, the firm has to recognize the amounts in preceding taxing period.
In cases where the firm’s core business is financial facilitation or intermediation to other firms, its annual income is subjected to taxation with less all the deductible expenses. And any interest earned on the loans and advances to its customers and clients is subjected to taxation. Where the business charge interest on overdue accounts but this is not its care business, it can claim income deductions on its total revenue.
Business credit as a form of financing reduces the net amount subjected to tax from the business income because interest charged on business credit is tax deductable and therefore. Unlike in equity financing, where the tax is calculated before the dividends and bonuses are paid off. Business credit can either be accountable or unaccountable. Utilization of business credit as a mode of financing implies that the company’s depreciation policies influence the method of business financing to a limit that has not completely been appreciated.
For a business that buys and sells goods and services on credit that are chargeable sales tax, taxation can be used to finance its operations. When a business buys goods on credit from another supplier, sales tax is declared after a certain period and the goods had been paid sales tax by the seller so the credit extension benefits the firm and vice versa. Specific provision for bad and doubtful debts is an expense which is tax deductable on the firm’s taxable amount and the firm does not pay tax on such expenses.
A business should use cash or accrual based accounting method in presenting its financial statements. This helps in accounting for any business credit accruing at the end of the fiscal year and thus ascertains the tax returns accurately. A business should choose a fiscal year that concedes with its business cycle. However in a debt-driven company the Internal Revenue system requires that the business use a calendar year.
Preparing tax forms once business credit is received
Internal Tax Service tax forms are used taxpayers and tax-exempt institution to record financial information and ascertain taxes to be paid to the federal government. Businesses file different tax forms depending on whether it is an individual taxpayer or the type of business under consideration such as a sole proprietor, company or a partnership. In the case where a business has received credit to boost operations, there are specific tax forms that it ought to file. Here are the variants in reference to business credit:
For an individual, he or she must fill Form 1040, United States Individual Income Tax Return. This form has eleven schedules and the following will have to be filled in reference to business credit. Schedule B if the individual receives or pays out interests or dividends; Schedule C shows the credit income and expenses related to sole proprietor; and Schedule F if the individual acquires business credit to finance business operations. In case of tax refunds or credit due to unclaimed deductions, an individual will file Form 1040X.
Sole proprietors use Form Schedule C to file incomes and expenses accruing from the business. The owner is taxed on income tax which is progressive tax as he or she files tax returns an individual. In the case the business utilizes business credit to finance its operations it must ascertain the expenses incurred to acquire further financing and incase it issues out credit to others it must recognize revenues generated. Individuals, partnerships and companies, file their capital gains and losses in Form Schedule D. Capital gains arise from disposing a fixed asset at a higher value than its book value while capital losses arise when a firm sells-off an asset at a lower value than its book value.
After business credit has been received there are some variants to be made in the Form 1099. This form is used to prepare and document an information return to record certain types of income to the business. These variants depend on the nature of the credit transaction and include; 1099-C where the firm’s debts are cancelled or written off. If a business distributes dividends or bonuses to its shareholders it must fill Form 1099-DIV.
When credit is engaged to finance the firm, there is a change in Corporate Control and Capital Structure and the firm is supposed to fill Form 1099-CAP. If a company issues credit to other firms, and generate interest income it should file a Form-INT. If after receiving credit a firm opts to be categorized under the Subchapter S – Corporation, it has to fill Form 2553 (called Election by a Small Business Corporation). This form is used to permit a firm to which is not a corporation by default to choose to be taxed as an S – corporation. This can be due to a change in the firm’s capital structure.
In the case the firm has issued credit extension to other firms outside the United States or obtained financing or from a creditor outside the United States, it must file a Form 2555 (called Foreign Earned Income). This identifies the credit income derived or expense accrued from sources in the overseas exempt from United States income tax. Form 2555 can also be used to claim no-taxable deductions. A taxpayer cannot exclude or include more than is earned or accrued from outside the country for the given tax year.
Every employer is required by the Internal Tax service to a fill a Form W – 2 for each worker who is paid a salary or wage, or any other form of compensation according to the employment contract. In some cases employers pay the employees after services have been delivered or pay for services in accruals, the employer is supposed to report this in the Form so that necessary deductions are made.
Managing a debt driven company with business credit
Acquiring business credit to start or sustain or expand the company’s operations involves a risk of getting into a more debt trap. Some companies rely more on credit transactions to as a way to retain customers or it’s the nature of the industry. There are mainly two sources of debt that a firm can incur. First are debts that are as a result of non-payment of dues or obligations. Sometimes businesses may opt to acquire goods or services on credit or borrow money to run its operations. If these goods are not settled promptly, they can lead to business debts. Second, bad debts that emanate due to pending settlement of accounts by customers or debtors. This can have an adverse effect on the liquidity of the business making it unable to settle debts and obligations on time.
Business debts have various adverse effects on the firm such as reducing value of the firm, undermining stakeholder’s confidence on its operations, make it unable to handle costs and reduce product quality. For a company financed through credit, the business has to settle its obligations on due time as they fall due and also pay of the cost of borrowing the funds either through interests or in case of grants foregoing certain opportunities. The company also has objectives which it ought to attain within a certain time frame.
Debt can also be used as a measure to balance the liquidity of the firm to ensure that the firm is stable. Although, if too much debt is employed, can lead to illiquidity of the firm and hinder its operations. Accumulation of debts can lead to bankruptcy and eventually liquidation of the company since it’s not able to honor its obligations. Poor debt management can lead to depreciation of the company’s value in the long term. Since the debt holders have an undertaken a risk in the business by financing it in case the firm is unable to honor its debts they risk losing their funds. Thus debt holders are also involved in making decisions pertaining the stability of the firm such the limit of debt accumulation and also the required levels of liquidity.
Business debt management involves managing the company’s debts to sustain the long and short term objectives of the firm. This process involves engaging qualified professionals to provide advice to the firm and enable it to handle debts effectively. In managing a debt driven company with business credit, the shareholders and debt holders can apply certain strategies; first, debt negotiation, the business enters into an agreement with its suppliers for debts on the debt limit, creditor’s turnover time and the charges involved in credit sales. Secondly, the firm should commit to debt elimination. This is aimed to maintain the various company’s debt, for instance it can decide to eliminate 100 percent credit card debt within a certain period.
Third, the firm can unveil a consolidation plan. This will assist in consolidating all the firm’s debts into one single debt and instead of the firm making many monthly installments, it only makes one payment to a single debt. Debt consolidation loans are charged a lower interest rate on a straight line basis as compared to the cumulative interest charged on debts or loans. Consolidation plan can be achieved through debt settlement, credit cards and business equity. Fourthly, in case where the firm is unable to collect funds from its debtors it can employ debt collection agencies to act on behalf of the company and collect the accrued debts. Fifthly, if all the above fails the last alternative is bankruptcy or liquidation. The firm can be declared bankrupt by a court of law, either through a direction of the creditors, owners or the company on its own capacity.