Use Employer Wages from 1120S K-1? No and here is why…

Lorna’s question:

I am looking at a complex personal tax return. This person owns an S-corporation 100%. The individual reports $37,000 in taxable wages (from this S-corp) on his most recent personal tax return. However, on his K-1 schedule, there is a line for employer wages totaling $301,000. I am wondering  how I should report the $301,000 in my cash flow analysis.

Linda’s answer:

Generally what we are looking for on the 1120S K-1 is distributions, having found the applicable wages on the shareholder’s 1040. This very question was also asked by Ryan this month, so I know credit analysts are looking closer at the K-1s for cash flow you can use. But you cannot use the wages listed on 1120S K-1…here is why.

First, where are the wages on the 1120S K-1?

You are seeing the $301,000 on Line 12 Other deductions, with a code of R.

This is not wages to the shareholder but a figure the 1040 preparer needs to have to determine the Domestic Production Activities Deduction (DPAD). It is the shareholder’s share of wages paid to everyone.

This is why tax return analysis for bankers is tricky…

Much of what is in the tax return has nothing to do with cash flow you can use. It is about taxable income and how it is calculated. And a lot of it is there so that the tax preparer can minimize client taxes using legitimate means. The DPAD is one of those means, and the figure you are seeing on the 1120S K-1 for Employer W-2 Wages is needed to calculate the DPAD.

Ignore this for your cash flow calculation.

The figure for Employer W-2 Wages, reported on 1120S K-1 Line 12 with a code of R, is a great example of information important to the tax preparer and of no use to the lender or credit analyst. Along with almost every other number on the K-1, it is needed for the tax preparer to make a required calculation in the 1040. But it is not cash-flow.

What is actual cash flow?

Actual cash flow includes wages already reported to him on his personal W-2 and reported on 1040, Line 7 as well as distributions on K-1 Line 16 with a Code of D. Also consider Repayment of loans from sharehol

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