Self-financing may be your best option

Self-financing may be your best option

Tapping into practice assets often easiest way to provide a cash infusion
Aug 01, 2008

Asurprising number of principals in veterinary practices depend on themselves for their financing needs. With conventional financing increasingly more difficult to obtain, it's now the No. 1 form of financing used by small business owners. It's quick, doesn't require a lot of paper work and often is less expensive than conventional financing.

The cost that comes into play is the "lost opportunity" cost — the amount that could have, or might have, been earned had those funds remained in savings or invested elsewhere. However, in the current economic climate, keeping financing within the family frequently produces the fastest and best results.

If you want to finance something yourself, know that the tax laws create a number of obstacles that must be overcome to avoid penalties and higher tax bills.

Reversing the bottomless pit

Although many veterinarians look first to cash savings as a financing source, often there are other assets that can be used, despite certain risks and drawbacks. Consider this example:

When John Jones' practice was turned down by several conventional lenders, even non-conventional funding sources seemed to dry up. His answer was to personally guarantee a $100,000 loan, run up expenses on his personal credit card and defer his salary. In short, Jones put himself in a position where he had a lot to lose — and the only way out was to succeed and profit.

Putting oneself at risk can attract lenders or investors to provide funds a business needs. Here are some strategies that can put the owner at risk, provide the needed funding — or both:

  • Liquidate savings. If you have it, consider giving it up.
  • Take out a home-equity loan. Remember, however, there is a limit to the amount of qualified residence interest that is tax-deductible. The aggregate amount of acquisition indebtedness may not exceed $1 million and the aggregate amount of home-equity indebtedness may not exceed $100,000. Interest attributable to debt that is over these limits is nondeductible personal interest.
  • Get a bank loan. Usually any bank loan will require a personal guarantee, or the guarantee of friends or family members.
  • Sell a vacation home.
  • Take out a margin loan against your stock holdings.
  • Never use personal credit card for business purposes. It is far too costly.

Imputed interest

When either lending to or borrowing from the veterinary practice, remember that, to count, it must be a legitimate, interest-bearing loan. A practitioner borrowing from his or her practice can face a hefty tax bill should the IRS view the transaction as a dividend payout rather than a loan.

Often, it is below-market interest rates or the lack of evidence of an arm's-length transaction that draw the attention of the IRS. The government is particularly interested in (1) gift loans, (2) corporation-shareholder loans, (3) compensation loans between employer and employee or between independent contractor and client and (4) any below-market interest loan in which the interest arrangement has a significant effect on either the lender's or borrower's tax liability.

If the IRS re-characterizes or re-labels a transaction, the result is an interest expense deduction when none was previously claimed and unexpected, taxable interest income on the lender's tax bill. The higher tax bills, often dating back several years, usually are accompanied by penalties and interest on the underpaid amounts.