When examining loan applications of potential small business borrowers, it’s important for lenders to consider the potential impact of deferred tax assets on a business’ financial performance.
That’s because it’s possible for businesses to use deferred tax assets to make their financial picture look better than it really is. Many companies that have experienced recent losses are now utilizing deferred tax assets in the form of net operating loss (NOL) carryforwards. These can be carried forward for up to 20 years and back for up to two years.
Utilizing deferred tax assets and NOL carryforwards is a legitimate small business tax-reduction strategy. However, lenders should assess how reasonable it is that the business will be able to realize the benefit in the future. Or put another way, how realistic is it that the business will have future operating income that the NOL carryforward can offset? Also, deferred tax assets are usually deducted by lenders when calculating the tangible net worth of a borrower.
Another thing to keep in mind is that deferred tax assets and NOL carryforwards will not appear on the financial statements of S corps, partnerships and LLCs. Nor will they appear on compilations, though GAAP requires that they be included in the reviewed and audited financial statements of regular C corporations. They will appear on a separate schedule accompanying small business tax returns.
Here are two takeaways regarding deferred tax assets and NOL carryforwards:
- If a borrower presents financial statements with significant deferred tax assets and NOL carryforwards, this might possibly raise a red flag. Dig a little deeper to determine how reasonable it is that they will be realized in the future.
- Just because you don’t see deferred tax assets and NOL carryforwards on a borrower’s financial statements doesn’t mean they’re not there. If a borrower has experienced recent losses, ask about any possible NOL carryforwards that aren’t disclosed. Considering them in your underwriting analysis could make the business a better credit risk.
Please contact us if you have any questions about this topic 417-881-0145.