BEST PRACTICES: 4506-T TAX VERIFICATIONS

Ethan W. Smith

SBA regulations require lenders to verify the financial information of applicants for loans under SBA loan programs. This verification is accomplished by submitting IRS Form 4506-T to the Internal Revenue Service for the most recent three years for the small business applicant. Simple enough? Not necessarily. For the unwary lender, failure to properly comply with the SBA's regulations regarding verification of the applicant's financial information can mean the difference between a guaranty purchase and a full denial.

The SBA has a strong interest in insuring loan applicants have filed their federal tax returns, and that the financial information provided to the lender for underwriting purposes matches what was provided to the IRS. From a public policy standpoint, the requirement makes perfect sense; the SBA does not want to reward businesses with federally subsidized loans, that fail to pay income tax or commit tax fraud. The only exception to this requirement is for startup businesses, in which case no 4506 is required.

Some common pitfalls lenders often run into that impair the SBA guaranty, are set forth below:

Failure to obtain 4506-T Tax Verification Transcripts on the Seller in a change of ownership situation;

Failure to obtain 3 years transcripts (or transcripts for each year in business, if in business for less than 3 years) and returns on the applicant or seller;

Obtaining 4506-T's on the EPC instead of the OC;

Failure to resolve any significant discrepancies between the returns and the transcripts;

When a business changes from a sole proprietor to an entity mid-year, failure to obtain transcripts for the partial year returns for both the individual and the entity;

Failure to obtain a transcript for the most recent fiscal year, if the FYE was more than 6 months from the date of the SBA application; and

Closing with only 2 of the 3 required years' transcripts (SBA allows an exception if the middle year is missing IF (and only if) the borrower provides satisfactory proof that it received a refund or paid taxes for the missing year). Additionally, in this situation where a transcript is missing, or when the lender is unable to reconcile the transcript to the tax return, the Lender is required to report the issue to the appropriate SBA Commercial Loan Servicing Center.

Failure to comply with these requirements will result in an automatic recommendation for denial of the SBA guaranty. Although lenders may attempt to demonstrate to the SBA how the failure to properly verify the federal tax returns did not contribute to the default on the loan, such arguments are difficult if not impossible to prove, and are rarely successful. Best practices dictate that lenders ensure that their processes ensure strict compliance with these regulations in order to preserve the SBA guaranty.

For more information on complying with the SBA's

4506-T requirements and for other SBA compliance issues, contact Ethan Smith at esmith@starfieldsmith.com or 215-542-7070.

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