What You’ll Learn:
- Whether invoice factoring fees are tax-deductible
- How to prepare taxes if your business has factored invoices
- A more favorable instant funding solution than factoring your invoices
Invoice factoring can be a great solution for small business cash flow problems, but it can create some irregularities when it comes to filing taxes. For example, transferring the ownership of your receivables to a factoring company often has an impact on how you report those receivables.
But is invoice factoring a tax deduction? And how do you accurately manage accounting for factored receivables? We’re here to walk you through how taxes work for invoice factoring and the deductions you can take for your business.
Can you deduct invoice factoring fees on your taxes?
Yes, you can generally deduct invoice factoring fees on your taxes. Factoring fees are considered a business expense.
However, like other business expenses, factoring fees need to meet IRS criteria for ordinary and necessary expenses. This means they might not be fully deductible if they’re deemed unnecessary or excessive. Additionally, working with a factoring company based outside the US can complicate the tax process.
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How to report invoice factoring on a tax return
Due to the complexity of accounting for factoring receivables, it may be helpful to work with a professional. That said, there are some steps you can take to prepare for filing your taxes after you use invoice factoring.
1. Maintain clear records
Any tax filing process relies on accurate records and documentation. Whether you’re a freelancer or a more traditional business, it’s crucial to have complete and organized records of all your transactions to make doing taxes easier. If you choose to work with an accountant, these records will help them as well.
2. Plan to pay taxes on full invoice amounts
Once you sell your invoices, the funds you receive are considered revenue. So while you can deduct invoice factoring fees on your taxes, keep in mind that you also need to report the actual invoice amount as income, pay taxes on that income, and report each invoice for the year you received payment from the invoice factoring company.
3. Choose reputable funding partners
Whether it’s the accountant you hire or the invoice factoring company you choose, working with qualified professionals can help ensure smoother outcomes for your business during tax season. You may also want to use a US-based factoring company to reduce potential complications. Working with a foreign company may require additional tax regulations and potentially even raise red flags with the IRS.
4. Keep track of invoice factoring volume throughout the year
As with all financial transactions, you should be mindful of how much you’re factoring over a tax year. This will help you avoid errors in filing—for example, reporting an invoice amount you didn’t receive payment for in the year you’re filing for.
If you’re working with more than one factoring company, it’s also helpful to meticulously track how much cash flow you’ve advanced with each one, as well as any differences in fees or factoring agreements. The more accurate your records, the easier filing taxes will be.
5. Note who takes responsibility for the invoice
If you factor an invoice and your customer ends up not paying, the party responsible for that debt depends on whether you have a recourse or non-recourse agreement with the factoring company.
A recourse agreement is one in which your business retains ownership over the invoice and is ultimately responsible for collecting payment on that invoice. If the customer doesn’t pay, your business is on the hook for the debt.
A non-recourse agreement involves the factoring company taking ownership of the invoice and payment collection process. They also take on the risk of the customer not paying what they owe.
What does this have to do with taxes? With a recourse agreement, your business may be able to claim a deduction for the bad debt on its taxes. With a non-recourse agreement, your business most likely can’t claim a bad debt deduction for an unpaid invoice.
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6. Pay attention to how factoring affects your overall income
The factoring receivables tax treatment can get complicated. You may find conflicting information about whether a factored invoice still counts as taxable income. Generally, this depends on the type of factoring agreement you have—specifically, whether you sell the entire receivable or receive an advance payment on a portion of that invoice.
If you have a recourse agreement and retain ownership of the invoice, the funds advanced from the factoring company aren’t taxable income. The full amount of the invoice is taxable, and you can report any factoring fees as business expenses.
If you have a non-recourse agreement, the amount you receive from the factoring company when you sell the invoice becomes your taxable income.
These guidelines may not apply in your situation, so it’s best to ask your accountant how a factored invoice affects your business income.
Do you need to use special tax forms if you factored any invoices?
No, invoice factoring doesn’t require special tax forms. A factoring company typically won’t send you a 1099 form, either. You simply report the invoice amount like regular business income—even if you sold the invoice to a factoring company. Meanwhile, the factoring company will likely report the fees it charged you on its taxes instead of the invoice it bought.
How Hopscotch Flow beats traditional invoice factoring
Hopscotch Flow is an alternative to traditional factoring that helps businesses get access to funding fast. Unlock 90% of your invoice in just a couple clicks, then get the remaining 10% (minus a small fee) when your client pays.
With Flow, there are:
Don’t let poor cash flow slow down your business.