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Form 1045 Tentative Refund for Cashflow?

Your question:

I received a Form 1045 “Application for Tentative Refund” 2007 form, decreasing tax year ended 2005. The client is reducing the amount owed from $444,062 to $17,077. I put this as a negative on federal taxes in the 2007 cashflow analysis. Should I do any more than this? Are there important questions I should ask?

Linda says:

We use the Form 1045 Application for Tentative Refund to carry back a few things. You are probably familiar with the idea of carryovers or carryforwards. Net Operating Losses are often carried forward (Line 21 of a 1040) and are one of the major noncash items we look for. Some types of losses can be carried back first, to get an immediate refund of past taxes paid. The Form 1045 is used in that case.

It has always been true that the NOL reduces federal taxes in the year it is carried to, whether that is forward or back. Here is what I need to know to advise you.

What kind of loss and what impact does it have on the business?

First, look at the Form 1045 and decide what caused the carryback. The form can be used to carry back an NOL experienced directly by the taxpayer or as a pass-thru from an LLC, partnership or S Corporation; Hurricane Katrina losses; unused general business credits; farming losses; disaster losses and some casualty losses.

What difference does it make?

If they are carrying back an unusual casualty loss, I am most interested in the immediate impact both of the casualty and of the refund of taxes. Yes, the refund of taxes reduces federal taxes this year. But have they recovered yet from the casualty? Was this a fluke or is it an indication of inadequate insurance?

If they are carrying back a Net Operating Loss from the business they are operating, what does that tell you about the health of the business and their success (or lack of it) in weathering the current economic downturn?

I am certainly not suggesting that any business with a loss this year or next is unusual or that you should cut them off. But I do suggest you watch your business borrowers closely for signs of difficulties so you can step in quickly to work with them if needed.

The Form 1045 Instructions can give you more detail on the type of carrybacks available, and how far back they can be carried.

Cashflow Impact? It depends.

This depends on whether you are calculating historical or recurring cashflow…and whether you use a before- or after-tax approach.

Historical Cashflow–After tax:

This lender is calculating what really happened after taxes were paid. I would add the refund to cashflow (or as the questioner did, reduce the amount of taxes I am subtracting). They definitely had more cashflow in 2007 (or perhaps 2008 by the time they got the refund) because of the reduction in taxes.

Historical Cashflow–Before Tax:

This is trickier. Since you are not subtracting federal taxes in the first place, adding the tax refund doesn’t sound right. But the likelihood is that your guideline (40% debt to income on personal analysis for example) assumes that the borrower is paying taxes on all their taxable income. And the year they get the refund, they are not.

So I still think I would add it, but as a nonrecurring income item.

Recurring Cashflow–After tax:

Unless it is a carryback that is not used up and will continue to carry forward as well, I would lean towards making no adjustment. But I would include it in the written write-up since it explains why they had extra cashflow in 2007, even if I do not think it is recurring.

Recurring Cashflow–Before tax:

Same answer. If you don’t think they will continue to have a cashflow impact from the excess loss or credit, you can’t use it in recurring cashflow.

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.