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What’s the significance of a final tax return?

Kimberly’s question:

One of my guarantors was in a now-ended partnership. The final tax return shows a loss, primarily made up of bad debts. What is the significance of this loss, given that the company no longer exists? Should I count it against my borrower?

Previous returns don’t show any bad debts at all, but this final return shows a large amount of bad debts. Is this a common practice?

Linda says:

For future debt repayment capacity, you probably do not need to count the failed entity. I do have a question, though..

Before you decide the financial impact of the closed business is over, ask more questions.

Does this owner have any continued real responsibility for debts or liabilities of the closed company? For example, if s/he was a general partner, s/he had complete responsibility for all partnership debts.

As to the bad debts, this may be the reason the company failed. Perhaps a major customer failed and this business had an over-concentration of risk, either in one customer or maybe in one segment. Consider what type of business it was to help you decide.

Another possibility is that they just were not consistent about recognizing bad debts in past years and were carrying receivables they would never collect. You would spot this only if you had an aging of receivables in prior years or perhaps if receivables were increasing year over year when revenues were not.

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.