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Global Cashflow of Pass-Through Entities:
Answers to Lender Questions

Sixty minute webinar | 275 lenders | 57 questions | 49 more minutes

In a sixty minute webinar on Global Cashflow of Multiple Pass-Thru Entities, 275 lenders chatted in 57 questions. I consolidated the duplicates and still had 37. By the time I created a video response to those questions, I had 49 more minutes of answers in 32 videos.


Watch the videos below to clear up the confusion and confidently handle pass-through entities in a global cashflow analysis.


Source of the Questions


Why formulas are not enough. Judgment required.

VIEW FIRST! I recorded this after the 30th question but I want you to view it first. Then view it again after you have seen the videos about your questions.


The topics and questions are:

  • Link to answers related to all tax returns
    • How many years’ tax returns do we need?
    • What is the difference between income and cashflow?
    • Questions on capital gains
    • How do we treat carryovers?
    • Four questions on debt
    • Which depreciation do we add back on a tax return?
    • Non-passive entities, blank front page and rentals
    • What (and where) are cash to accrual adjustments?
  • Link to answers about 1040 tax returns
    • How can you spot K-1 pass-through interest on a Schedule B?
    • 1040 Schedule E: What numbers should we use (or ignore)? Impact of Passive vs Non-Passive
    • Do we need to adjust projected federal taxes for cashflow adjustments?
  • Link to answers about global cashflow
    • How do you define Global Cashflow?
    • How do you handle owner contributions?
    • Do I count a % of entity cashflow or the entire amount?
    • Can you run a global cashflow with two different years returns for the personal and the pass-through entity?
    • What do you recommend for family living expense?
    • Can you require tax returns of the spouse of a guarantor, especially if the family cashflow is dependent on that income?
    • How do you handle partial ownership of a pass-through entity?
    • How do you avoid double-counting?
  • Link to answers about high net worth borrowers
    • Can I use the trust income listed on the 1040?
    • Can we count on asset conversion?
    • If there is not a guideline, which returns should we get?
  • Link to answers about Ks and K-1s
    • Does the 1120S include the K-1?
    • With K-1 cashflow, should I use the average or the most recent?
    • What if you can’t get the K-1s?
    • Can we use distributions from Schedule K?
    • How do you verify loan payments or repayments to a shareholder?
    • Cash vs Property contributions and distributions: does it make a difference and how do you tell?
    • Do you use 1120S paid-in-capital in cashflow calculations?
    • Do you use distributions from the K or the M-2?
    • Isn’t EBITDA a more reliable number than K-1 cashflow?
    • What if a high % guarantor took no distributions? What should you use?

    Questions about all Tax Returns

    How many years’ tax returns do we need?

    Includes advice to a lender new to a borrower who is not new to your financial institution.


    What is the difference between income and cashflow?

    Includes a personal example as illustration.

    Resources:
    Online module: Green Legos, Six Ns and a Map to Tax Return analysis
    Manual Page 1-8 thru 1-11: Tax Return Analysis – Essentials and 1040 Review


    Questions on Capital Gains

    Includes where you find them, cash impact of short-term vs long-term, what is always missing on Schedule D and 4797 and what other documentation I recommend.

    Resources:
    Online module: Capital Gains and Losses: Schedule D and 4797
    Manual Page 2-30 thru 2-35: Tax Return Analysis – Essentials and 1040 Review


    How do we treat carryovers?

    This answer applies to any tax return. It includes the nature of carryovers and my ‘always’ rule for how to handle them.

    Resources:
    Online module: Green Legos, Six Ns and a Map to Tax Return Analysis
    Manual Page 1-10 thru 1-22, 2-31: Tax Return Analysis – Essentials and 1040 Review


    Four questions on Debt

    Debt is not only about pass-through entities. These answers cover debt on any business returns.

    1. Why don’t we ‘add back’ principal payments as well as interest expense?
    2. Do you count the entire balance of current liabilities against cashflow?
      • Includes short-cut for debt from a balance sheet
    3. If they are not required to pay credit cards in full, would you still count the full balance in the DCR?
      • Includes expected and stressed situation
      • Includes difference between credit card balances and operating lines of credit
    4. Do you net the personal debts prior to calculating DCR?

    Resources:
    Online module: Debt, Debt Ratios and Debt Shortcuts
    Manual Page 1-9, 1-25: Tax Return Analysis – Essentials and 1040 Review
    Manual Page 2-9/15, 3-13/21, 4-13/19: Tax Return Analysis – Corporations, Partnerships and LLCs


    Which depreciation do we add back on a business return?

    I answer five questions on depreciation including:

    • What do we add back?
    • Does it depend if we started with taxable income or net income per books?
    • Is there an advantage to starting with net income per books?
    • How do we handle Section 179 depreciation?
    • What is the aglending substitute for tax return depreciation?

    Resources:
    Online module: Depreciation in Tax Returns and Financial Statements
    Manual Page 2-23/24, 2-42 thru 2-46: Tax Return Analysis – Essentials and 1040 Review
    Manual Page 2-20 thru 21: Tax Return Analysis – Corporations, Partnerships and LLCs


    Non-passive entities, blank front pages and rentals

    The mystery of the blank front page of an 1120S or 1065 return is solved. I’ll tell you where to find the rental info and why it is there.

    Resources:
    Online modules:
    1065 Company Cashflow
    1120S Company Cashflow
    Manual Page 3-19/27, 4-17: Tax Return Analysis – Corporations, Partnerships and LLCs


    What (and where) are cash to accrual adjustments?

    Includes discussion of the M-1 adjustment and the confusion caused by a cash-basis tax return with an accrual basis Schedule L Balance Sheet.

    Resources:
    Online module: Cash vs Accrual Basis
    Manual Page 2-23: Tax Return Analysis – Essentials and 1040 Review



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    Questions about 1040 Tax Returns

    How can you spot K-1 pass-through interest on a Schedule B?

    One of my favorite answers: “It depends.”

    Resources:
    Online modules:
    1040 Schedule B: Interest/Dividends; Notes Receivable; K-1 Pass-thru
    1120S Company Cashflow
    Manual Page 3-19/27, 4-17: Tax Return Analysis – Corporations, Partnerships and LLCs


    1040 Schedule E: What numbers should we use (or ignore)? Impact of Passive vs Non-Passive

    I rarely use the words ‘always’ or ‘never’ regarding tax return analysis, but I come pretty close in this video. I answer these four questions:

    1. Should we ignore E-2 completely?
    2. What is actual cash inflows on Schedue E Income?
    3. Do we use E-2 taxable income or k-1 distributions/contributions?
    4. Does it matter if it is listed as passive or non-passive?

    Resources:
    Online modules:
    1065 Company Cashflow
    1120S Company Cashflow
    Manual Page 3-11, 4-11: Tax Return Analysis – Corporations, Partnerships and LLCs


    Do we need to adjust projected federal taxes for cashflow adjustments?

    By now you know the answer is likely to be a strong “maybe”. Here is what this two-minute video covers:

    • When you deviate from personal AGI for cash flow, how would you make adjustments to personal tax liability?
    • The difference in before-tax and after-tax approach
    • The difference between historical and recurring analysis
    • A simplified method to make the adjustment

    Resources:
    Manual Page 2-15: Tax Return Analysis – Essentials and 1040 Review



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    Questions on Global Cashflow

    How do you define Global Cashflow?

    Business lenders and personal lenders have a different take on what global cashflow is. Be sure you and your colleagues are in sync on the definition.


    How do you handle owner contributions?

    Actually, this turned into three questions. It depends on whether all guarantors are included in the global and how you are counting the contributions against the owners, if at all.


    Do I count a % of entity cashflow or the entire amount?

    The lender wants to know whether to use a % of cashflow available or the entire cashflow. It depends…


    Can you run a global cashflow with two different years returns for the personal and the pass-through entity?

    Sometimes the personal return is on a calendar year and the business return on a fiscal year. But sometimes you have a more recent personal return than the most recent business return. Should you do a global on two different years returns?


    What do you recommend for family living expense?

    Linda covers the age-old “whatever-it-takes-to-make-the-loan-work” approach as well as methods more likely to pass muster with the loan committee.


    Can you require tax returns of the spouse of a guarantor, especially if the family cashflow is dependent on that income?

    Just how far you can go when requiring tax returns to calculate global cashflow. What if the guarantor’s spouse owns other pass-through entities? Can you require, or even request, the spouse’s returns? What risk do your run when you don’t?


    How do you handle partial ownership of a pass-through entity?

    Answered briefly here, partial ownership of pass-through entities is the basis for many of the other questions and answers on this page. Read this one and then look for the other relevant answers to flesh it out.


    How do you avoid double-counting?

    Double counting is one of the most frequently mentioned concerns of lenders when it comes to pass-through entities.You may be surprised at how short this answer is. Although the other videos will reinforce the answer.



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    Questions on High Net Worth borrowers

    Can I use the trust income listed on the 1040?

    There are simple and complex trusts. But because of complex trusts, a lender needs more information than the 1040 can provide. Linda explains.


    Can we count on asset conversion?

    There continues to be a debate around lending based on cashflow and lending based on asset conversion. Linda provides a way to consider the liquid assets, regardless of your approach.


    If there is not a guideline, which returns should we get?

    High Net Worth borrowers pose many challenges, the least of which is the sheer quantity of tax returns. If we could decide based on the weight of the file, they’d get the loan every time. So what returns do I recommend with a complex borrower?


    Questions on Ks and K-1s

    Does the 1120S include the K-1?

    In all of my programs I stress asking for the K-1. This lender wants to know if when you ask for the 1120S, the K-1 is included.


    With K-1 cashflow, should I use the average or the most recent?

    When using the K-1 to calculate personal cashflow of a business owner, guarantor or complex borrower, should we take the most recent cashflow or average several years? Decide what you think before you view the video.


    What if you can’t get the K-1s?

    The most important question i can answer about K-1s is, more accurately, about missing K-1s. This is one of the biggest bones of contention between loan officers and underwriters. Find out the risk you run when you do not get the K-1s and still need to determine business owner/guarantor cashflow.


    Can we use distributions from Schedule K?

    It is not uncommon for a number we need in our cashflow calculation to be in two places on the return. This lender wants to know if Schedule K is an appropriate source for distributions to subtract from the entity cashflow. Of course, i answer that and a related question. I just can’t help myself!


    How do you verify loan payments or repayments to a shareholder?

    Besides asking the question asked, in my answer, I asked (and answered) another question. Do you need to verify the loan payments?


    Cash vs Property contributions and distributions: does it make a difference and how do you tell?

    Includes discussion on contributions and distributions as well as the difference in how it is coded on the 1065 K-1 and the 1120S K-1. Linda explains why information varies so much from one return type to another, responds to a question about accountant adjustments and wonders if the OCC Examiner in
    one question was right when they expressed concern about whether a distribution was cash or property.


    Do you use 1120S paid-in-capital in cashflow calculations?

    The 1120S K-1 does not give us capital contributed. This video comments on an alternative source to discover capital contributed.


    Do you use distributions from the K or the M-2?

    Distributions show up on the K, the K-1 and the M-2. Learn which to use and how to avoid the opposite of double-counting.


    Isn’t EBITDA a more reliable number than K-1 cashflow?

    The debate between actual cashflow from a K-1 and share of cashflow from the source pass-through entity rages on unabated. Linda weighs in with a surprising caution.


    What if a high % guarantor took no distributions? What should you use?

    The question was whether to use share of entity cashflow with a high % owner guarantor who took no distributions. It led to a broader discussion of why distributions might be significantly different than available cashflow and what a lender needs to know.



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