What You Need to Know About Loan Restructuring and Debt Forgiveness
By Garry Bartecki
Article Date: 09-01-2009
Copyright(C) 2009 Associated Equipment Distributors. All Rights Reserved.
Consequences and tax implications as you examine your options
I know things are tough and it looks like it will remain status quo for at least another 18 months. During this industry depression a lot of dealers are doing what they have to do to keep the lights on. But even though you are not making any money there is still planning that has to be reviewed to avoid unpleasant situations at a time when you really don’t need them.
This depression is causing a lot of loan restructuring. In some cases, the dealers just can’t cope with their loan arrangements and are hoping to restructure their terms considering interest rates, principal payments, length of the loan, the monthly payment amounts, etc. Some banks are getting out of the dealer business and have called all the existing loans, creating quite a dilemma for the dealer who cannot replace the financing.
As a result of this economy and changes in the banking environment, many dealers find themselves unable to refinance their loans, unable to make the required payments and maybe just paying the interest on the outstanding balance. In addition, banks understand that the longer they allow these situations to continue the less they are likely to collect what is owed them. In some cases, they may even be willing to accept a discount to get out of the relationship. What that may do, however, is create taxable income for debt forgiveness, which is not an uncommon occurrence. And if your company is a flow-through entity, guess where that phantom income winds up: On your 1040, that’s where.
This is not uncommon. The bank comes to you and says: Pay us 50 percent of the balance you owe us and we will forgive the rest. The “rest” is what you pay tax on, which you can’t do, of course. Consequently, there is discussion going on whether having a flow-through entity now is a good idea when compared to a C-Corp. This is a very valid question for anyone who may find themselves in this situation. Changing from a flow-through to a C-Corp you can do, but to get the result you are looking for may be more complicated. So being proactive before it hits the fan makes a lot of sense in this case.
Another dealer problem has to do with the depreciation he/she will not have because of MACRS, Bonus Depreciation and Section 179 write-offs taken to date. Dealers are not and probably will not add to their depreciable assets for some time, and thus, even if you reflect a break-even on your books you may not have the tax depreciation to generate the same results. To make matters worse, dealers are selling off used equipment to generate cash flow and many of these assets have been written down for tax purposes. As a result, the sale of these assets generates ordinary taxable income that will not be offset by new tax depreciation charges.
The next big problem I see are dealers with material tax balances due as we are coming out of this depression. Better stay on top of your tax planning or you may be in for a big surprise. And if you have not filed your 2008 business return yet, you may still have time to make changes to avoid unpleasant results or increase the value of your tax benefits.
To make matters worse, if you have not paid federal income taxes for a while, don’t forget you will get a double dip the first year. Make the year-end tax payment and also file estimated tax payments that same year? Really, not a good idea.
Another area to focus on during these thrilling times is your personal guarantees. Better know what is going on here and keep in mind these are negotiable as well.
Right now everything is negotiable, so do not wait to inform your lenders about problems. Work out your cash flow budgets and inform them as soon as possible about an upcoming problem. They will work with you on every level as long as you have some staying power to keep moving forward. But don’t forget that part of this solution is to do your corporate and personal planning as well so you know how much leverage you have in the process. Helping you reach the recovery stage is a win-win for all concerned. But if you can’t, you certainly don’t need to add to your woes with avoidable tax exposure.
AED’s CFO Conference will tackle these issues and more. Call me for details.
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