Small-business lenders are crying foul following a decision by the Internal Revenue Service to restrict their access to borrowers' tax information.
Last week, the IRS issued a policy update stating only lenders making residential and commercial real estate loans would be permitted to access the Income Verification Express Service, the platform the agency uses to transmit tax returns to lenders.
"The IRS will only provide IVES transcripts to mortgage lending firms for the sole purpose of obtaining a mortgage on residential or commercial real property (land and buildings)," the update — made public January 2 — stated.
The stricter policy takes effect June 30.
The decision will add time, complexity and expense to the process of obtaining a loan, according to small-business lenders. That is especially true for those that participate in Small Business Administration lending, since the SBA requires inclusion of tax returns in all the loan packages it reviews.
"I think it's going to cause some serious disruption," Ryan Metcalf, Funding Circle's head of U.S. public affairs, said Tuesday in an interview. Funding Circle is one of three nondepository small-business lending companies
The ability to obtain tax returns from the IRS is an important tool in underwriting and preventing fraud, Metcalf and other small-business lending sources said. "What it essentially means is we have to have borrowers go and get their tax returns and send them to us," Metcalf said regarding pending IVES restrictions. "We'll have to do a lot more forensic auditing and checking of the returns knowing there's a break in the chain — or borrowers have to go to their [accountants].
"It places more burden on applicants," Metcalf added. "If you have to go to your CPA and have them pull two years of tax returns, it's just a costly process."
Tax returns play a critical role in verifying a borrower's income, according to Christopher Naghibi, chief operating officer at the $13.1 billion-asset First Foundation in Dallas. "Boiled down to its most basic, underwriting a loan comes down to knowing the income and expense of your loan applicant," Naghibi wrote in a statement to American Banker. "Without having reasonable comfort levels with their income, you are essentially flying blind."
Lucas Bianchi, CEO and cofounder of Namaste Credit, called the IRS' decision a "net negative" for small-business lenders in a statement. Echoing Metcalf, Bianchi said lenders will be able to find other avenues for verifying borrower income, but added the alternatives would likely not provide the same level of accuracy, speed and efficiency direct access to IRS data offers.
Prior to the COVID-19 pandemic, lenders, including small-business lenders, were able to access IRS' IVES system via secure fax machines. Lenders would fax a request. The IRS would fax the data in response. The system was simple, but slow, routinely taking two weeks or more for returns to reach lenders.
The Taxpayer First Act, enacted July 1, 2019, required the IRS to ditch the fax machines and automate IVES. Paradoxically, however, Metcalf cited the law's implementation as the point at which things began to slide downhill for lenders. In 2021, IRS introduced a new authentication system, requiring borrowers to create an account with the agency and use its ID.me system to prove their identity in order to request that a tax transcript be sent to a lender. Metcalf characterized the process as cumbersome and time consuming.
"They introduced significant friction into the process and burdened the applicant," Metcalf said. "The way that it works, practically, if you're in a loan application process, either for a mortgage or a small-business loan, you have to close the application and go to the IRS."
Now, with the decision to limit IVES to mortgage lenders, the IRS has "taken it to a whole other level,' Metcalf said.
"The thing that they're really squandering here is the opportunity to create innovation in the lending market that reduces fraud and costs and increases the speed and ease in which consumers and small businesses can access capital," Metcalf said. "That's what Congress mandated the IRS to do and they're not doing it.
"Obviously, the IRS is not working with or listening to the industry or other government agencies on how to modernize this system that's in the best interests of consumers and small businesses," Metcalf added.
The new policy will make it tougher for small businesses to obtain credit, according to Naghibi. "Combining this challenge in the years following 14 years of artificial interest deflation and you have a very tough road for access to credit for these borrowers," Naghibi said.
