How to Use Tax Returns for Global Cash Flow with Multiple Pass-Through Entities

Global Cashflow w/ Linda Keith CPA 19-Mar-15

Copyright © 22015 Linda Keith CPA Inc. All rights reserved. | Resources at www.LindaKeithCPA.com/Sageworks 1

Use Tax Returns for Global Cash Flow with Multiple Pass-Through Entities

Questions

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About Sageworks

+  Financial information company that provides credit and risk management solutions to financial institutions

+  Data and applications used by thousands of financial institutions and accounting firms across North America

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+  NC Tech Awards: Excellence in Customer Service



About Linda Keith CPA

+  She provides credit training to financial institutions throughout the country with a focus on Tax Return Analysis and Financial Statement Analysis

+  Linda is an expert in Business & AgLending, Lending to the Wealthy & other Complex borrowers

+  She trains in both in-person and virtual formats and for in-house or open-enrollment audiences

+  Linda’s Sageworks Webinars are the most forwarded and have the highest attendance of our Credit Analysis Topics.

Please chat in your hot bu/ons on global cashflow.

© Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 5

My plan for the webinar: •  Compare notes with others through polls •  Consider your Guidelines and take back a list •  Watch me walk-through three cashflow scenarios:

•  Entity-only Cashflow with Margin and DCR approach

•  Global Cashflow (Business and Personal focus) •  Owner Cashflow (3 ways)

•  Ask questions

My HOT buttons are: •  Double Counting by mixing up taxable income, actual cashflow and

cashflow available. (I guess that could be triple-counting!) •  Using 1040 Schedule E, Page Two figures for pass-through entities •  Using a formulaic, numbers-only approach without adding judgment

Who is your borrower?




B&J Floors

Jan owns 25% Ben owns 67%

Zac owns 8%


Poll Question 1 What type of loans do you and your team typically make? ( Choose all that apply) 1.  Business (C&I) 2.  Business (CRE) 3.  AgLending – Production 4.  Mortgage Lending 5.  Consumer – Direct or Indirect


Poll Question 2 What is your role? ( Choose one) 1.  Loan Officer or Business Development Officer 2.  Credit Analyst/Underwriter 3.  Lending or Credit Manager 4.  Senior Lending Officer 5.  Something else

© Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 9



Ben owns 67%

Zac owns 8%


B&J Floors

Jan owns 25%

Poll Question 3 Business Lenders…who will guarantee your loan? (Check all that apply) 1.  65% owner Ben 2.  25% owner Zoe 3.  10% owner Zac 4.  All owners regardless of % 5.  It depends on something else


Note the results on your handouts for later comparison.

Ben owns 67%

Zac owns 8%

þ

þ

© Linda Keith CPA Inc Mar 2015 | 12

B&J Floors

Jan owns 25%



© 2013 Fiserv, Inc. or its affiliates.

Guideline Question

© Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks.htm | 13

1120S

1040 1040

© Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks.htm | 14

1120S

1040 1040

Jan owns 25% of B&J Floors Inc Jan owns 100% of Odds N Ends Medical Clinic Inc

1120S 1120S K-‐1 OR OR 1120S

1120S K-‐1




Poll Question 4 Assume you are lending to B&J Floors and require a guarantee from Jan. What returns do your guidelines require? (Pick one.) 1.  Odds N Ends 1120S 2.  Jan’s K-1 from Odds N Ends 1120S 3.  Both the Odds N Ends 1120S & the K-1 4.  It depends…it might go either way. 5.  I do not do business lending

© Linda Keith CPA Inc Mar 2015| Resources at www.lindakeithcpa.com/sageworks.htm | 16


Guideline Question


1120S

1040 1040

Jan owns 100% of Odds N Ends Medical Clinic Inc

1120S 1120S K-‐1 OR OR 1120S

1120S K-‐1

Hubby Dan owns 90% of Valley Vineyards LLC

Dan owns 10% of Donut Shop

1065 1065 K-‐1 OR OR 1065

1065 K-‐1

1120S K-‐1

| 18



Poll Question 5 You are lending to B&J Floors and requiring a guarantee from Jan who is married to Dan. What additional returns do you need? (Pick one.) 1.  Valley Vineyards 1065 and Donut K-1 2.  Valley Vineyards K-1 and Donut K-1 3.  Valley Vineyards 1065 & the K-1 from both 4.  None of these choices 5.  I do not do business lending

© Linda Keith CPA Inc Mar 2015| Resources at www.lindakeithcpa.com/sageworks.htm | 19

1120S

Jan owns 100% of Odds N Ends Medical Clinic Inc

1120S 1120S K-‐1 OR OR 1120S

1120S K-‐1

Hubby Dan owns 90% of Valley Vineyards LLC

Dan owns 10% of Donut Shop

1065 1065 K-‐1 OR OR 1065

1065 K-‐1

1120S K-‐1

1040 1040

B&J Floors: Borrower

Ben 67%

Jan 25%

100% Odds N Ends Medical

Dan: 90% Valley Vineyards

Dan: 10% Donut Shop

Zac 8%




1065 K-‐1

1120S K-‐1


Ben 67%

Jan 25%



Dan: 10% Donut Shop

Zac 8%

1120S

1040

1040

1120S

Other Options: 1040 1065 1120S

K-‐1



Ben 67%

Jan 25%



Dan: 10% Donut Shop

Zac 8%

1040 1065 1065 K-‐1

1120S K-‐1

1040

1120S

1040

1120S 1120S K-‐1


Jan and Dan Borrower

Jan: 25% B&J Floors

Jan: 100% Odds N Ends Medical


Dan: 10% Donut Shop

1040

1065 1065 K-‐1

1120S K-‐1

1120S

1120S

1120S K-‐1

1120S K-‐1





Guideline Question



Guideline Question



Questions on which tax returns to require?




It all starts with the Entity Return Income Passes Through to the Owner

28

1065 Information only

K-1

1040 A

B

D

E

Pass-throughs

K-1


Business Income is subject to Social Security Tax.

1065

K-1

1040 A

B

D

E

Pass-throughs

Charitable contributions Interest/Dividends Capital Gains/Losses

Business Income/Loss

Example: Net Capital Losses limited to $3,000.

K-1




1065

K-1 K-1

1040 A

B

D

E


Business Income/Loss Actual Cashflow to Partner: Guaranteed Pmnts + Distributions – Capital Cont Also consider rents, loans or loan repayments.

Cashflow Available to Partner: Use partner’s share of 1065 cashflow plus his/her Guaranteed Payments.

Use K-1.


1120S

K-1 K-1

1040 A

B

D

E


Business Income/Loss Actual Cashflow to Owner: And consider rents, loans or repayments to the owners.

Cashflow Available to Sharholder: Use partner’s share of 1120S cashflow plus his/her Wages.

Use K-1 Distributions.

Wages


Entity-Level Analysis of a Pass-Through for Business Loan Goal: Cashflow Available to Pay Debt using DCR or Margin/Deficit Guideline/Procedure Questions: •  What is our guideline for DCR or Margin? •  Do we worry about a deficit or low DCR

before doing the global?

Global Analysis of a Pass-Through for Business Loan Goal: Cashflow Available to Pay Debt using DCR or Margin/Deficit Guideline/Procedure Questions: •  Who will guarantee? •  If I do not require all owners to guarantee,

how to I get an accurate DCR? •  What if a guarantor is an owner in another

pass-through? •  For DCR analysis, what will I use for family

living expense? © Linda Keith CPA Inc Mar 2015 | 33



Poll Question 6 What is your approach regarding DCR? 1.  We have a guideline at the entity level 2.  We have a guideline at the global level 3.  We use DCR but do not have a guideline 4.  We do business loans but do not use DCR 5.  This question does not apply to me



Guideline Question



Guideline Question




Poll Question 7 When calculating DCR for Global CF, what do you use to estimate family living expenses? (Choose all that apply) 1.  General guidelines or number in the home 2.  Lifestyle of borrower (boats, planes, hobbies) 3.  What it takes to make the loan work 4.  AgLenders: Live on-farm or off-farm 5.  This question does not apply to me


Owner Analysis of a Pass-Through for a Personal Loan Goal: Cashflow from the Entity to the Owner Guideline/Procedure Questions:

How do I decide between actual and available cashflow? Do I ever use Schedule E, Page 2 taxable income/loss?

Guarantor Analysis of a Pass-Through for a Business Loan Goal: Cashflow from the Entity to the Owner Guideline/Procedure Questions:

How do I decide between actual and available cashflow? Do I ever use Schedule E, Page 2 taxable income/loss?

EnUty K-‐1

1065 K-1 1040

E Taxable Income


Poll Question 8 When do you use taxable income from 1040 Schedule E, Page 2 for owner/guarantor?(Choose all that apply) 1.  When the pass-through entity is not obligated 2.  When the owner has a low % ownership 3.  When it is on the passive (left) side 4.  I always do 5.  Rarely or never





Questions on deciding between actual and available cashflow for owner/guarantor analysis?



Contact Information & Additional Resources

Resources +  20 Video Series on Pass-Through Entities +  Recordings of and resources from this and

previous Sageworks Webinars +  Global Tax Return Analysis Quick

Reference Guide +  Red Flags and Green Lights in Tax

Returns: Extended Handouts


Owner Cashflow Actually Paid What happened in the checkbook?




Source +/-‐ Item Amount

1065 Box L or 19 (Code A) PLUS Withdrawals

1065 Line 4 PLUS Guaranteed Payments

1065 Box L MINUS Capital Contributed

1120S 16 (Code D) PLUS DistribuUons

1120S 16 (Code E) PLUS Repayments on Loans

Equals Cash Paid to Owner

Owner Actual Cashflow from a pass-through

K-‐1

When you use this: •  You are lending to the owner of a pass-through •  You are calculating cashflow to a guarantor from another pass-through entity


Poll Question 9 What cashflow from the business will you use for personal cashflow?(Choose all that apply) 1.  Rents paid to the owner 2.  Loans made to the owner 3.  Repayment of a loan from the owner 4.  Payment on a note payable to the spouse 5.  Distributions and guaranteed payments


Assume all have been recurring sources.

Guideline Question




Actual Personal Cashflow


1065 Box L or 19 (Code A) PLUS Withdrawals $25,910

1065 Line 4 PLUS Guaranteed Payments 30,000

1065 Box L MINUS Capital Contributed -‐0-‐

1120S 16 (Code D) PLUS DistribuUons


Equals Cash Paid to Owner $55,910


Handout Page 3

1120S K-1 5|31

CORPORATION PARTNERSHIP & LLC RETURNS¤ Linda Keith, CPA, Inc. January 2014

SECTION 5:Case Study 1

B&J Floors 1120S, Schedule K-1See Page 4-22 For Help

1120S© Linda Keith CPA Inc Mar 2015 | 47

5|31




1120S

1120S K-1


1065 Box L or 19 (Code A) PLUS Withdrawals

1065 Line 4 PLUS Guaranteed Payments

1065 Box L MINUS Capital Contributed

1120S 16 (Code D) PLUS DistribuUons 13,914


Equals Cash Paid to Owner $13,914





Questions on what the owner got paid?


What can the company afford? To cover debt or pay the owners


$40,000 is the guaranteed payments to ALL partners. Form 1065 Page One

40,000

51



Form 1065 Page One Owners pay taxes on both guaranteed payments and ordinary business income.

65,961 52

Form 1065 Page One

65,961

Bo=oms Up Analysis +/-‐ Item Amount

1065 Line 22 PLUS Taxable Income $65,961

1065 Line 15 Add Interest Expense 1,451

1065 16a Add DepreciaUon 1,174

K (various lines) PLUS or Minus

Interest, Rentals etc 150

M-‐1 (various lines) PLUS or Minus

Disallowed meals, etc -‐135

Equals Cash Available to Pay Debt and distribuUons to owners

$68,601

53

Form 1065 Page One Top Down Analysis +/-‐ Item Amount

1065 Line 1 -‐ 8 PLUS Revenue $207,139

1065 Line 21 Minus Expenses -‐141,178





Net Profit $65,976

1065 15 Add Interest Expense 1,451


Cash Available to Pay Debt and distribuUons to owners

$68,601

54



Form 1065 Page One

Top Down Analysis +/-‐ Item Amount

1065 Line 1 -‐ 8 PLUS Revenue $207,139

1065 Line 21 Minus Expenses -‐141,178





Net Profit $65,976

1065 15 Add Interest Expense 1,451


Cash Available to Pay Debt and distribuUons to owners

$68,601

Cashflow Available to pay Debt Cashflow Available to Pay Debt

68,601 Available $68,601

DistribuUons

Available for Debt

Debt

Margin

DCR

51,820 51,820

16,781 16,781

14,451 14,451 $2,330

1.17

© L

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Poll Question 11 If you calculate DCR, what are you looking for? (Choose all that apply) 1.  1.25 or less 2.  More than 1.25 3.  It depends on why it is low 4.  It depends on loan-to-value 5.  It depends on liquidity


Guideline Question




5|23



B&J Floors 1120S, Page oneSee Page 4-12 For Help

1120S

© L

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Kei

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Inc

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8

Bo=oms Up Analysis

+/-‐ Item Amount

1120S Line 21 PLUS Taxable Income -‐22,870

1120S Line 13 Add Interest Expense 26,907

1120S 20 Add DepreciaUon 6,911


Interest, Rentals etc




$10,325

5|23



B&J Floors 1120S, Page oneSee Page 4-12 For Help

1120SBad Debts

© L

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Global Analysis Let’s put it all together…





Ben 67%

Jan 25%



Dan: 10% Donut Shop

Zac 8%

1040 1065 1065 K-‐1

1120S K-‐1

1040

1120S

1040

1120S 1120S K-‐1


Bo=oms Up Analysis

+/-‐ Item Amount









$10,325


Debt List Amount

B&J Floors Debt Payments

$26,000

.

.

Total Debt Service

Personal Amount

Wages (including Scorp) $100,000

Capital Gains -‐0-‐

Schedule E Gtd Pmnts -‐0-‐

CF other than School Tools $100,000

Ben Personal Debt payments

26,604

52,604

Global Amount

B&J Floors $10,325

Ben 100,000

Available from income 110,325

Less Family Living

Less Income Taxes

Available for Debt

Combined Debt

Global Margin

Global DCR

-‐40,000

-‐26,000

$44,325

52,604

-‐8,279

.84

Bo=oms Up Analysis Item Amount

Cash Available to Pay Debt and distribuUons to owners $10,325




5|27



B&J Floors 1120S, Page FiveSee Page 4-20 For Help

1120S

5|31




1120S

The company paid out $20,892 in distributions

The company paid Ben $13,914 in distributions

If you are not requiring Jan or Zac to guarantee you need to subtract the extra $6,978 from company cashflow somewhere! I would do it in ‘other expense’ on my worksheet. © Linda Keith CPA Inc Mar 2015 | 64

Jan and Dan Borrower

Jan: 25% School Tools

Jan: 100% Odds N Ends Medical


Dan: 10% Donut Shop

1040

1065 1065 K-‐1

1120S K-‐1

1120S

1120S

1120S K-‐1

1120S K-‐1


Bo=oms Up Analysis

+/-‐ Item Amount









$10,325




Bo=oms Up Analysis Item Amount

Cash Available to Pay Debt and distribuUons to owners $10,325

Global Amount

B&J Floors X 25% $2,581

Odds N Ends X 100%

Jan

Available from income

Less Family Living

Less Income Taxes

Available for Debt

Combined Debt

Global Margin

Global DCR

-‐36,000

-‐26,000

$115,490

47,500

67,990

2.43

Personal Amount

Wages (including Scorp) $80,000

Alimony 30,000

Other -‐0-‐

CF other than Pass-‐Throughs $110,000

Debt List Amount

B&J Floors Debt Payments X 25%

$6,500

Odds N Ends

Jan Personal

Total Debt Service 47,500

14,400

26,600

64,909

110,000

177,490

Odds N Ends 64,909

-14,400 $50,509

Debt to Income Ratio 47,500/177,450 = 27% © Linda Keith CPA Inc Mar 2015 | 67


Guideline Question



Guideline Question




Owner Cashflow Taxable Income Actual Cashflow

Cashflow Available


We’ll find this on 1040, Page one.


1040 Line 17

Taxable inc

ome from Pass-‐

Through En

UUes




Actual Personal Cashflow



$38,594

$24,999

Actual AddiUonal Cashflow to owner

50,509

Available Personal Cashflow to owner

Paid taxes on her share of taxable income.

Guidelines based on: •  Pattern •  % Ownership

Lenders consider: •  Guidelines •  Common Sense •  Judgment





Steps for multiple pass-through entities:

1.  Diagram the relationships 1.  Who is your borrower 2.  Who must guarantee 3.  Which returns do you need when

the owner/guarantor owns an unrelated pass-through business

2.  Obtain all required returns 3.  Decide for each pass-through entity

other than the borrower which to use: 1.  Actual cashflow from the K-1 2.  Cashflow available to the owner

calculated from the full return times the ownership %

4.  When calculating 1040 cashflow, use K-1 cashflow or entity share of cashflow instead of any K-1 pass-through items (Schedule E Page Two, Schedule B, Schedule D, etc.)



Done but not done!

Managers: •  Modify and communicate

guidelines to give clear but flexible guidance.

•  Check that your worksheet or software counts, but does not double-count, pass-through entity cashflow in your global calculations.

•  Provide the recording of this webinar and other resources to your team.

•  Work to help your lenders and analysts move beyond formulaic number-crunching to insights and understanding



Lenders and Analysts 1. Understand your guidelines 2. Review the webinar or other

resources 3. Request the 20-Video

Series and other resources

Done but not done!




Contact Information & Resources

Linda Keith CPA [email protected] 360.455.1569

Websites +  www.LindaKeithCPA.com

+  Resources, blog, articles, training +  www.LendersOnlineTraining.com

+  Self-Study eLearning +  www.TaxReturnAnalysis.com

+  Four-week Virtual Training +  www.TheLendersAcademy.com

+  Become a BETA Partner

Resources +  20 Video Series on Pass-Through Entities +  Recordings of and resources from this and previous Sageworks Webinars

+  Global Tax Return Analysis Quick Reference Guide +  Red Flags and Green Lights in Tax Returns: Extended Handouts

+  Sign-up for ‘Lenders Q&A’ email with answers to real questions each month


How to Use Tax Returns for Global Cash Flow with Multiple Pass-Through Entities

Economy & Finance

Transcript of How to Use Tax Returns for Global Cash Flow with Multiple Pass-Through Entities