By THOMAS J. DUFFY
As we all know, whether we want to admit it or not, online payday lenders are cannibalizing the market share of the traditional brick and mortar lenders.
Loans transacted on the Internet are increasing at an estimated rate of 15 percent to 20 percent a year, according to payday lending consultant Jer Ayles-Ayler of Newport Beach, Calif. Ayles-Ayler started multiple brick and mortar locations throughout the California area back in the late 1990s. As the Internet blossomed, he embraced the online payday model.
Not only did Ayles-Ayler embrace it, he mastered it and did very well. He did so well that he retired from active management and now works as a consultant to the industry.
You may be wondering how to make the change when all you have ever known is brick and mortar. Ayles-Ayler advises getting involved with various organizations and associations of lenders.
Attend the conferences and you will be amazed at the overwhelming amount of information you will receive. There will be a plethora of industry professionals, vendors and online lenders present who will be happy to answer your questions and assist you in moving to the online model. Knowledge is power in online lending.
Working Your Advantage
According to Ayles-Ayler, the greatest obstacle for new online entrants is the ability to generate Web traffic and quality leads.
If you are a brick and mortar operator, you have a greater chance of succeeding in the online space than someone without the advantage of a brick and mortar location that is jumping directly into online payday lending.
You have the advantage of a physical location with a physical advertising space that people notice, whether they want to or not.
You can harvest this advantage. Ayles-Ayler says that one of the most powerful tools in the arsenal of brick and mortar operators is their established customer base.
It is imperative to make your current customer base aware that, in addition to the retail location, you will also be launching or has launched an online lending site.
Various incentives could be offered to encourage customers to make their next loan online. There could also be some type of referral or VIP program for existing customers and their friends and family.
It’s important to note that online lenders are choosing to lend into most of the 50 states under a variety of licensing models.
This includes the choice-of-law model, the state licensing model, the sovereign nation model and the offshore model. We will leave the legal ramifications of this to the attorneys, but note that the opportunity to lend into all 50 states is an amazing opportunity not afforded to the brick and mortar operators.
What are the tax implications of incorporating the online model? Let me start by stating that more and more of the online lenders we work with are choosing to operate internationally. Many refer to this as the offshore model.
The offshore model encompasses many complex tax compliance and reporting matters that will be discussed in future articles. For now, we will focus strictly on the tax implications of operating a domestic online lending entity.
Generally speaking, a domestic entity refers to an entity that is formed in the United States. The tax implications for an online domestic entity are not too dissimilar from a domestic brick and mortar location. Usually it is recommended that an online lender set up a domestic limited liability company.
Team Work Vital
Your accountant should work in conjunction with your attorney when planning the structure of your online lender, as your risk tolerance will dictate this structure.
It is important to note that your online entity will be taxed in the same manner as your brick and mortar entity is taxed for federal tax purposes.
Legal fees, though hefty, are certainly necessary and the treatment of these fees for tax purposes is very important.
Many new entrants face large penalties from the IRS for the incorrect treatment of these costs.
Legal and accounting costs necessary to organize the partnership and to facilitate the filings of the necessary legal documents are referred to as organizational costs. Organizational costs are generally capital expenditures. Capital expenditures are not deductible in full in the year incurred, but are amortized over a 15 year life.
However, currently you can deduct up to $5,000 of organizational costs in the current year and you must amortize the remainder of these costs over 15 years.
The $5,000 immediate expense is reduced dollar for dollar when organizational costs exceed $50,000.
Please note that under certain limited circumstances these costs may fit the definition of business expansion costs and thus result in a full and immediate deduction. It is important to consult your tax advisor regarding your specific situation.
1099s Protect Deductions
Also, it is important to note that fees paid in excess of $600 to an attorney must be reported on a form1099-MISC.
There are no exceptions. It is strongly recommended that you issue 1099s to any and all service providers as this solidifies your deductions in the eyes of the IRS.
The 1099s are easy to prepare and are well worth it. I recently attended an IRS audit of a client who claimed in excess of $300,000 in professional fees. He failed to issue a 1099 and failed to keep copies of cancelled checks and bank statements.
The IRS subsequently denied the entire deduction. Had a 1099 been issued he would have saved more than $100,000 in taxes, interest and penalties.
The costs incurred for various IT, computer equipment and software packages can be fully expensed under the Sec. 179 or Bonus depreciation provisions of the Internal Revenue Code. (See Cheklist magazine, Summer 2011, “IRS: Once in A Lifetime Opportunity” for an expanded discussion of the deprecation provisions and planning opportunities for 2011).
Finally, where is that tax planning nugget you have been waiting for? A little known deduction, often overlooked by many professionals, is something known as an investigation expense. Investigation expenses are basically the expenses incurred in investigating the potential for a new business. If your investigation results in a new business formation, you can deduct those expenses.
Under a special provision in the tax code, you are eligible to elect to deduct up to $10,000 of these expenses as start-up expenses in 2010 ($5,000 in years thereafter) with the remainder being amortized over 180 months. The $10,000 cap is reduced dollar for dollar once start-up expenses exceed $60,000.
Thomas Duffy is a CPA with Kutchins, Robbins and Diamond. Contact him at (847) 240-1040, ext.181