I see most of this forum seems related to residential questions, so maybe I'm in the wrong area. Please excuse me if this is the case. Newbie here.
I looking for clarification on the Bank's obligations, responsibilities and liabilities towards commercial applications from individuals obviously mis-representing their income to the IRS? Can these loans be approved without major consequences to the Bank? The Bank's legal counsel states the approval of such loans will not expose the Bank to any additional risks. Maybe I am just overly conservative but seems to me there could be additional risks to the Bank on closing such loans. Any advice, opinions and past experiences in this area would be greatly appreciated. Thank you.

Your attorney may be entirely correct about the legal risks, BUT if they lie to the IRS, do you think they'll have any trouble lying to you? I believe underwriting based on unreported income to be very questionable.

I agree with Jokerman and I think lending under those circumstances is questionable. Also, in these cases I also believe that a SAR should be filed. I attended a BSA conference the other day and the criminal investogator from the IRS told us that they review EVERY SAR that is filed and have caught many "tax cheats" this way. In your case, I think you are obligated to file a SAR on these people.

Definite SAR consideration - I am in a resort area where many many businesses (including hotels and motels) will only deal in cash. They apply for loans and don't qualify because the income they are reporting Tax returns isn't enough - they then are stupid enough to go through this speil that they can bring in their "books" and show us their true in come - unreal!

We have a saying at our bank, "if you don't report it, you can't borrow against it." If a borrower doesn't show enough cash flow on his/her/its tax return to support the debt, then they are out of luck with us.

Just a little rant. These people who underreport their income make my blood boil. My taxes are higher because they are not paying their fair share.

Either the borrower has character (and plays by the rules) or he is a character.

So this issue is simply character related and not an IRS policy or banking regulatory violation? Short of filling a SAR, there's nothing stopping an institution from lending against such borrowers? This seems unethical or am I being overly conservative?

Most (mortgage) underwriters want verifiable income, and a form 4506-T is obtained as a method of verification with the IRS.

(If you accept what they say, how do you determine to whom the applicant is lying - you or the IRS?)

I agree with SC Banker-if it isnt reported, we dont consider it. If we determine the customer gave us fraudulent docs, we file a SAR. Why would a lender loan money on unreported income? As stated above, if they are lying to Uncle Sam, they are probably lying to you too.

I agree, I need PROOF that you can pay back this loan. You normally collect paystubs to verify income, right? How is a tax return any different? I am W2 employed and my wife is self employed. We report what we get, and that's it. No fooling around. We take advantage of all the deductions we can, that is not illigal, but we NEVER screw with the truth. The tax savings (at the tax rate) is not worth the audit price.

I too have had uneasy feelings about this over the years, but my two previous employers allowed it freely. I even asked a couple of examiners about it and they said undocumented ability to cash flow is a watch credit, but they did not consider the bank the IRS tax police. So at both banks I had a large watch list, but some loans of this nature were made regularly.

This individual claims he has been mis-reporting his income for more than 20 years and, to date, has not been audited. From the tax returns presented i would say he is most likely telling the truth about not reporting all of his income. I agree with all of you about this appalling situation but i have not heard a valid regulatory violation (IRS or Banking) stated, just valid opinions and philosophies. I am looking for some sort of violation to report this activity under, other than a SAR. Not comfortable completing a SAR on a fellow employee who has a different opinion/philosophy regarding this applicant's reported income.

Ah, then you understand my situation perfectly Razor. This is the first employer i have worked for where this behavior has been tolerated.

I thank all of you who have responsed or will respond!

Creditcop hit it on the head - documented income counts - undocumented income doesn't. How are they proving to you that they have undocumented income??? Are they just telling you and giving you the ol' wink-wink? Credit decisions made on that are sure to be subject to criticism.

Unless other banking activity suggests they are doing something illegal - what are you really basing a SAR on. A comment someone made - forget it? If they falsify an application form or a financial statement in an attempt to get a loan - that however is another situation.

And - well secured or not - fighting for your collateral when Federal tax liens are involved is not a walk in the park.

bump

I would remind my BOD that under-reporting income to avoid paying income taxes is called tax evasion and it is VERY illegal. It is not just tax liens you have to worry about, your borrower could go to jail. That would make collecting the debt very difficult!

You will find no such laws. This is truly a safety and soundness issue in the your credit underwriting process. Your only salvation would be for your safety and soundness regulators to pick up on it and criticize the bank for lending based on unproven cash flow or for the bank to get burned once.

I’m assuming that all of the anonymous posts are the same person. Piecing them together yields a situation where the bank has copies of the individual’s tax returns, income reported on the returns is considerably less than the income claimed on the application and that the individual has made clear verbal statements that he has intentionally underreported his income to the IRS. When a customer’s reported income is less than the income they claim on their loan application, you consider filing a SAR for loan fraud or false statement, not income tax evasion. Item 35 on the SAR gives you some choices:

e Commercial Loan Fraud

18 U.S.C. Section 1344
18 U.S.C. Section 656/ 657- Embezzlement, theft or misapplication of funds

- Embezzlement, Theft or - Bank Fraud
A fraudulent loan involving a corporation, commercial enterprise, or other type of business, usually secured by some form of collateral. One example includes banks advancing loan funds to car dealers via floor plan lines of credit secured by the automobiles in inventory. Collateral is later sold, out of trust, and proceeds are not applied to the loan thus creating a loss to the lender.

g Consumer Loan Fraud

18 U.S.C. Section 1344
18 U.S.C. Section656/657- Embezzlement, Theft or Misapplication of Funds

A loan extended to an individual for personal or household use that is obtained fraudulently.
- Bank Fraud Incidents of consumer loan fraud primarily involve the submission of false or forged statements by loan applicants.

n False Statement

18 U.S.C. Section 1001- False Statements or Entries
18 U.S.C. Section 1005 False Entries
18 U.S.C. Section 1014 Loan or Credit Application

A person who knowingly and willfully commits one of the following:
1. Falsifies, conceals or covers up by any trick, scheme or device, a material fact;
2. Makes any materially false, fictitious or fraudulent statement or representation; or
3. Makes or uses any false writing or document knowing the same to contain any materially, fictitious or fraudulent statement or entry. The false statement must occur in a matter within the jurisdiction of a branch of the United States Government; essentially, making a false statement to a government agency when it is carrying out its mission.

Section covers oral or written false statements or misrepresentations made knowingly on a loan or credit application to an insured bank (e.g., willful over-valuing of land, property, securities, or other assets or the understatement of liabilities). Such statements or misrepresentations must have been capable of influencing the bank's credit decision. Actual damage or reliance on such information is not an essential element of the offense. The statute applies to credit renewals, continuations, extensions or deferments and includes willful omissions as well as affirmative false statements. Obsolete information in the original loan application is not covered unless the applicant reaffirms the information in connection with a renewal request. The application will trigger the statute even if the loan is not made.

My personal favorite in your situation is “n.” While people who would say, “Oh, he’s not lying to us, he’s lying to them,” are entertaining, I would not say their judgment is of the highest quality. Moreover, he either made a false statement to you or to the IRS - both fit under this category.

As a sidebar issue only, if he's been cheating on his taxes for the last 20 years, he might get by with it for the next 20. On the other hand, the IRS might be reviewing his 2003 return right now and drop the net right in the middle the project you are financing. If, as your Loan Committee suggested, you get a letter from his lawyer saying there are no pending IRS investigations that letter will not be subject to the attorney client privilege. If the IRS gets a hold of that letter via a summnons and realizes you knew or should have known about the income tax fraud in prior years, my best guess is that you should record your liens on toilet paper, because that's what they will be good for.

Ken, where could I get a list of the other definitions for item #35? I am working on a BSA program for lending officers and want to provide this information along with the sample situations that are reportable.
I looked at what FinCEN had on line and couldn't find these definitions. Thanks.

The 7th Issue of the SAR Activity Review contains a list of the categories of suspicious activity, the federal statutes involved and an explanation/ description of each. Using the document’s page numbers (not those of the PDF file) see page 40.

SAR Activity Review, #7