The Five Keys to Accounting for Loans at Tax Time

It might seem daunting to try to make sense of your loans when it’s time to do quarterly assessments or annual tax returns.  Business finances from loans are actually not too hard to manage, as long as you keep in mind two or three key ideas.

Interest, Fees and Points – This Is Your Profit

All the interest you receive, the fees you collect, and the points you were paid when the loan began – thee things are your profit.  They’re income, and taxable in most situations.  You don’t need to separate these numbers.  Their total is how much revenue you brought in from lending.  In some places, you can’t report the points or origination fees as profit all at once, you have to report them over the scheduled life of the loan.  In most other places, you report the fees and points as profit as soon as they’re received.

Charge Offs – These Are Your Losses

If you have given up on collecting a loan and have to take a loss, you write-off the unpaid principal balance.  You’re not writing off interest or fees that didn’t get paid, that was just profit you never got to make.  The principal you paid out but didn’t get back, though, that’s a direct financial loss.  It’s the same as any other business expense.  Something you had to pay in the course of ordinary business.  This number comes directly out of your business revenue.

Principal Outstanding – Money Still Invested

Your principal outstanding is the money you still have out.  Principal you disburse throughout the year isn’t an expense, because the money is converted directly into an asset of equal value.  Principal in and out isn’t revenue or expenses, so it doesn’t affect your taxable income.

Unearned and Earned Discount – When You Bought a Loan for Less than the Principal Balance

This situation is less common, but definitely worth mentioning.  Discount Earned happens when you buy a loan for less than its principal balance.  If you paid half of a loan’s balance to buy it, then half the principal that comes in is technically profit.  This profit is called discount earned.  In Moneylender, when you set a purchase price that’s less than the principal balance, your discount is paid out in proportion to the principal paid.  This discount should be added to the interest, fees and points for your total revenue.

The remaining discount from your savvy purchase remains theoretical on your loan as Unearned Discount.  This number is available as a column in Moneylender’s reports.  If you charge off a loan, you’ll need to subtract the discount unearned from the charge off amount before treating it as an expense.

Escrow Accounts – It’s Not Your Money, but You Have to Account for It

Escrow accounts are usually under strict regulations.  The money that comes and goes from the escrowing of taxes and insurance does not affect your profit or loss.  It is money that should be sitting in your bank account (or at least be somewhere highly liquid) that you hold in reserve for your borrowers to ensure your seniority on any liens.  While not money that affects your bottom line, you will have to be able to show on demand the full accounting for funds held in escrow on a borrower’s behalf.

That’s it!  Really not too complicated after all, right?  If you’re splitting the revenue among investors, that might throw a twang or two into the process, but you’re really just putting these same numbers together for each investor.  Moneylender can produce single-investor reports for exactly this purpose.

How much did you make?  How much did you lose?  That’s all you need to know to figure out your taxes on your lending activities.

Brought to you as always by Moneylender Professional – Loan servicing software for businesses and professionals.  Trusted by smart investors.  Scorned by its competitors!

 (Pricing accurate at the time of this post, subject to change.)

Got a situation that adds a fourth or fifth type of profit to the mix?!  Share it in the comments!  Thanks for reading.