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Nondeductible Expense: #2 in the list of 6

Tax return analysis gets us from taxable income (on any return) to cashflow. There are Six Ns that get us there and here is #2.

The most common nondeductible expense adjustment is for 1/2 of meals and entertainment. If I show $890 of meals and entertainment, I must have spent $1,780.

Some lenders figure I have to eat anyway, and it is ‘kind of’ optional to splurge on this. I think it depends on the business. In some businesses, you really need to entertain to get clients or you have to travel and gosh, you just have to eat.

Another possibility:
Excess premiums on officer life insurance. If it is on a corporate or partnership return, you’ll find these on Schedule M-1…last line on the left.

And I suppose we could add principal payments on loans to this list. Interest is deductible if it is a business loan, but not the principal.

That is actually a good thing. If we got to take a tax deduction for the repayment of the loan, that would mean we would have included the borrowed money in taxable income. That does not sound so good!

What to do?
For  historical cashflow, include the nondeductible expense. You do this by subtracting it if you started with taxable income. Or you list it with the other expenses if you are recreating their income/expense list.

For recurring cashflow, decide whether to include it depending on whether you think it is likely to recur.

If it is debt, add back the interest expense associated with the loan payment. Then either subtract the loan payments if you are going for net cashflow after payments…or put the debt payments on a separate list if you are going for cashflow available to pay debt.

Any others?
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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.