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1040/V1

Tax ReTuRn analysis: essenTials and 1040 Review

2011 Forms and schedules

linda Keith cpa, inc.po Box 1366

olympia, Wa 98507360.866.1982

WWW.LindaKeithCPA.com

All Materials copyright protected. You may reproduce worksheets for use in your company.

Copyright Linda Keith CPA, Inc. January 2012

Section 1: Introduction

ESSENTIALS AND 1040 REVIEW1-2

Linda Keith, CPA, Inc. January 2012 1040/V1

Do It Now!

DO IT NOW!!!Use this sheet to write down the bright ideas you get in the workshop or as you review the manual. What questions do you need to ask a senior lender or look up in loan policy? What adjustments does your company not make that you think are a good idea and should be proposed? Any questions about your company’s guidelines? When you get back to the office or finish your review of the manual, turn to this page and pursue these items...NOW!

1: Within one week of the workshop, review the loan request checklist (page 1-14).

2: Within one week of the workshop, analyze at least two 1040 tax returns.

1-3Section 1: Introduction

LINDA KEITH, CPA

Linda Keith, CPA, Inc. January 20121040/V1

About LINDA KeIth, CPADIsCLAImer

Linda Keith, CPA, CSP works with banks and credit unions to maintain and improve loan quality and to implement a relationship-based approach to lending.

She helps lenders say “Yes” to good loans.

Linda is known as the CPA who likes to play. Making the right loan decision is serious business. But there is no reason not to have some fun while learning about it. People learn better when they are having fun.

exPerIeNCe · Public Accounting and Tax Practice · Training lenders since 1986 · Open-enrollment workshops · Onsite training · Real Estate investor · Commercial borrower many times over

for family-owned construction company · Invited by the Central Bank of Russia to

present on business lending in 1994

CreDeNtIALs · Certified Public Accountant…you know

what that is! · Certified Speaking Professional…the

highest earned designation from the National Speakers Association, the premier professional association of independent keynoters and trainers in the country. Only 10% of our members have achieved this designation.

AffILIAtIoNs · American Institute of Certified Public

Accountants · eLearning Guild · Risk Management Association · National Speakers Association

LINDA KeIth CPA, INC.

You maY have heard the phrase: “a carpenter is onlY as good as his tools. ” the right tools reallY help with complex tasks.Linda brings her easy-to-understand explanations from the classroom to the printed and online world.

eworKsheets

Excel-based because we all know how to use Excel™, Linda’s worksheets walk you through the process of tax return analysis.· Includes built in help boxes · Easy to review the work of others or

yourself · Flexible to fit your guidelines or approach · Excellent and consistent documentation

LeNDer’s oNLINe trAININg™ At your fINgertIPs

Access eCourses when you need them at www.LendersOnlineTraining.com.· Short, concise, convenient and practical

(each is 30 minutes or less) · Take the eCourses after live training as a

refresher · Includes additional topics Linda cannot

fit into the live-training agenda · Fast-paced, interactive, colorful...

just like Linda!

LINDAKeIthCPA.Com

Also found at our website.... · Linda’s Good Loans Blog· Ask Linda Section· Articles and more.....

Please note: This publication is designed to provide accurate and authoritative information in regard to the subject covered. It is sold with the understanding that the author is not engaged in rendering legal or accounting services. This manual should not be used as a substitute for adequate training or consultations with professional advisors, when necessary.

Policies and procedures vary. Consult the policies and procedures of your company or a senior lender before making adjustments recommended here.



Linda Keith CPA, Inc. January 2012 1040/V1

section 1: introductionwelcome ....................................................................................................1-6Basic approach.........................................................................................1-8variations on the methods ......................................................................1-9what to look For: the six ns ................................................................1-10suggested procedure For cashFlow analYsis ......................................1-12loan request checklist ...........................................................................1-14copYright notice .....................................................................................1-18cashFlow worksheets with help notes .................................................1-19reo Form .................................................................................................1-29

section 2: Forms and explanationssample tax return explanation .............................................................2-2cashFlow worksheets .............................................................................2-3keY to icons...............................................................................................2-9Form 1040, page one .............................................................................2-10Form w-2, wages ...................................................................................2-12Form 1040, page two .............................................................................2-14schedule a: itemized deductions ...........................................................2-16schedule B: interest and dividends .......................................................2-18schedule c: proFit or loss From Business ............................................2-22 Basics list ...............................................................................................2-23 overview list ..........................................................................................2-23 cashFlow the schedule c .....................................................................2-24 line-BY-line notes ................................................................................2-24 advertising: line 8 ...........................................................................2-24 car & truck: line 9 ........................................................................2-24 depreciation: line 13 .....................................................................2-24 insurance: line 15 .............................................................................2-24 interest: line 16 .............................................................................2-25 legal and proFessional services: line 17 .......................................2-25 pension and proFit sharing: line 19 ...............................................2-25 repairs and maintenance: line 21 ...................................................2-25 taxes and licenses: line 23 .............................................................2-25 disallowed meals: line 24B ..........................................................2-25 wages: line 26 ..................................................................................2-25schedule c, page two .............................................................................2-26 other expenses: line 27 ...................................................................2-27 home oFFice deduction: line 30 ....................................................2-27summarY oF schedule c analYsis ..........................................................2-29schedule d: capital gains & losses, page one ...................................2-30 noncash items ....................................................................................2-31 lines 4 and 11: undistriButed, like-kind, installment ..................2-31 line 13 capital gain distriButions ..................................................2-31


LINDA KEITH, CPA

Linda Keith CPA, Inc. January 20121040/V1

gains/losses From stock and real estate .....................................2-32 nonrecurring .....................................................................................2-32 active traders: stock ........................................................................2-32 active traders: real estate...............................................................2-32 sell-oFF: stock ..................................................................................2-33 sell-oFF: real estate .........................................................................2-33Form 8949: sales & other disposition oF capital assets .................2-35 schedule e, page one: rentals .............................................................2-36schedule e: partnerships, s corporations, estates, trusts .................2-38schedule F: proFit or loss From Farming .............................................2-40Form 4562: depreciation ........................................................................2-42Form 4684: Business casualtY losses ..................................................2-46Form 4797: sales oF Business propertY ...............................................2-48Form 6252: installment sale income ....................................................2-50Form 8582: passive loss activitY..........................................................2-52Form 8824: like-kind exchanges ..........................................................2-54Form 8829: home oFFice ........................................................................2-56Form 8949: sales & other disposition oF capital assets (see 2-35)asking questions .....................................................................................2-58schedule c worksheet completed .........................................................2-60rentals worksheet completed ................................................................2-62completed worksheets............................................................................2-63next steps..................................................................................................2-64

section 3: case studY driller return

section 4: case studY carpenter return

section 5: solutions

section 6: the endcashFlow worksheets .............................................................................6-3excell worksheets instructions .............................................................6-13index .....................................................................................................6-15




weLCome

WELCOME! You have chosen to invest time in gaining the full use of an important loan-qualifying tool. You may be sitting in a workshop or studying this manual on your own.

YOU WILL increase your competence and confidence in making loan decisions when you are lending to a business or your borrower has income from self-employment, rentals, RE contracts or capital gains.

YOU WILL be able to create stronger relationships with your borrowers by• moreinformeddiscussion• moretargetedquestions• saying“yes”togoodloans.

YOU WILL gain information and practice skills that will help you personally move forward in your job and career.

I PROMISE YOU IT WILL BE A WISE INVESTMENT.

Lenders attending this workshop or using this manual tend to have a wide variety of previous training and experience. It will be helpful for you to set a goal that is appropriate for your background. Take a moment to consider your starting point.

How long have you been a lender? What type of training have you had on tax return analysis? Do you analyze tax returns currently? Do you use tax returns daily? ...once a week? ...once a month? Is your focus consumer, real estate or commercial lending?

Having answered those questions set

yourself a realistic goal. If you are relatively new to tax return analysis or you use it very infrequently, your goal may be exposure to what is possible and mastery of the basic procedure and approach. You will need to use the manual as a continuing resource and refer to it often.

Because I target the workshop/manual to work for a range of lender experiences, there may be some specific comments or references that you don’t quite understand. Don’t let that throw you.

On the other hand, if you have been lending for quite some time or you use tax returns daily your goal will be to fill in the gaps and better understand what you already know from experience. You would expect to pick up on more, if not all, of the specific tips, traps and recommendations.

By setting a realistic goal for yourself, you can get the most from the information provided. You can move the farthest distance from your starting point. For many of you attending the presentation it will be a stretch.

There is no one way to do tax analysis. Be sure to consult with written policies/guidelines, a senior lender or underwriter before applying any specifics you learn here. It is not my place to change your financial institution’s procedure or policies. Those guidelines have been chosen based on risk culture and other factors. Between my information and your hard work, we will increase your ability to understand and use tax returns, whatever your system.


LINDA KEITH, CPA


MY GOAL IS: seLf stuDy stuDeNts:If you are not attending this session, see the note to you on page 2-2 for how to get the most out of the case studies. As with my in-class students, you will get a hands-on walk-through of three tax returns. All the information you need is in this workbook.

eworKsheet users: Throughout this workbook there are instructions relative to the Excel based eWorksheets we have developed that allow you to prepare the worksheets on your PC. If your company has purchased our eWorksheets, you’ll find the instructions on page 6-13 and throughout this manual helpful.

If you do not yet have the eWorksheets, you can order directly at our website and download today or use the form on page 6-19.

The worksheets you prepare on your PC are the same format as those in this manual. If you have a question while doing the analysis, just mouse over the item description and a help box pops up.

The eWorksheets automatically do the math and carry numbers forward from rental, sole proprietorship, corporation and partnership worksheets. You still make the judgment calls.




bAsIC APProACh

There are two basic approaches being used widely by lenders in determining 1040 cashflow. I’ll call them the Adjustment (AGI) method and the Schedule Analysis (S/A) method. There are variations on each.

ADjustmeNt (AgI) methoD: In the adjustment method, you start with the bottom line of the tax return. I call this ‘tax return income’ but the official label is Adjusted Gross Income (AGI) on a 1040, Ordinary Income on a Partnership or S Corporation return and Taxable Income (before NOL and Special Deductions) on a Corporate Return. You then review the information in the return to make adjustments to this bookkeeping/tax number to get to the real number you are interested in: recurring cashflow available to your borrower.

sCheDuLe ANALysIs (s/A) methoD: In this method, you derive a cashflow figure to use in your qualifying income calculation by building it item-by-item. You look at each source of income and decide if you will include it and/or if it needs adjustment before including it. You also look for income items that may not be on the return or legitimately not fully reported. When analyzing business or rental income, you switch to the adjustment method for that schedule by starting with the bottom line of that form.

methoDs useD IN worKshoPs AND mANuAL:When presenting on-site training sessions I teach to the guidelines, methods and worksheets you use. In the ‘open-enrollment’ workshops, I teach both methods. The manual has instructions and solutions for both.

ADvANtAges of AgI methoD:With the AGI method, I think it is easier to review the work of a junior lender. You can easily see what adjustments have been made and summarize the difference between the number the borrower gave

you, AGI, and the number you are using in your qualifying income calculations.

It also is easier to self-review. When I am done with an AGI analysis, I look at my starting number and try to put into a couple of sentences the main reasons why it is different than the recurring cashflow I am crediting to the borrower. This is the last chance to catch mistakes like adding something when I should have subtracted it or reading a decimal point off of the calculator incorrectly. The AGI method makes this last thought process easier.

ADvANtAges of sCheDuLe ANALysIs methoD:This method is more intuitive for many. You end up with a list of what cashflow sources you expect.

eIther wAy: You need to review each item in a return and know what items may not be there that do have impact on cashflow. Either way you need to decide what to include and not to include in RECURRING CASHFLOW. The information you gain from the workshop and the manual will work for either method.

hIstorICAL AND/or ProjeCteD CAshfLow

We all need to get to recurring cashflow to make a good loan decision. Consumer and mortgage lenders often do this in one pass through of the 1040, leaving out nonrecurring income like the occasional capital gain from a stock sale. They usually average the ‘projected’ cashflow from the most recent two or three years.

Commercial and commercial real estate lenders often prefer a two-step method. They may do a historical/actual cashflow analysis of two or three years first. What did happen in the checkbook?

Once they have a good understanding of what has been happening with cashflow, they are in a better position to project the future cashflow.

On page 1-10, the types of adjustments are separated into historical/actual and projected/recurring to accommodate


LINDA KEITH, CPA


vArIAtIoNs oN the methoDs

either approach.

Debt-to-INCome rAtIo

This ratio is used by some lending institutions to evaluate personal loans or the strength of a business guarantor. The personal debt is divided by the net cashflows from all sources including wages, investments, rentals and self-employment.

Debt payments related to business or rentals are generally subtracted from business or rental income rather than included in personal debt.

Debt-to-Income ratios range from 35% to 50% if using gross wages (before-tax)...or 45% to 60% if using net wages (after-tax).

Some financial institutions use a sliding scale. The higher the income, the greater debt-to-income ratio they allow.

Net sPeNDAbLe

Instead of using a debt to income ratio, some lenders subtract a family living expense based on number in the family and perhaps the income level. Then they either subtract debt (the answer needs to be positive) or they divide the result by debt from all activities (see debt coverage ratio below.)

Debt-servICe or Debt-CoverAge rAtIo

The income before interest deductions is divided by the debt. We add back the interest wherever we find it and enter the corresponding debt on the debt list.

A debt-service ratio of 1.2 to 1.3 is often required. Sometimes the ratio can be lower if the residual (after-debt) income is higher. Your guidelines may provide for a sliding scale.

With a closely held business, the debt figure used often includes personal, rental and business debt. If so, the allowable ratio may be higher to accommodate family living expenses. Check your internal guidelines.

Commercial lenders need to subtract sole proprietor/partner s’ withdrawals, recurring corporate dividends or S corporation distributions to owners to determine how

much cashflow was left in the business to cover the business debt.

before-tAx versus After-tAx

When analyzing business owner’s returns, before-tax figures give you an equivalent to gross wages in a debt-to-income ratio approach. In my experience, before-tax is used by most consumer/mortgage lenders and perhaps half of commercial lenders.

When using a before-tax approach, and assuming a 40% debt-to-income ratio, the taxes are covered by the other 60% of income along with food, clothing and other expenses. It is simpler than after-tax because you don’t have to consider the tax impact of the various adjustments you are making.

The debt-to-income ratio allowed is greater when using an after-tax income figure — perhaps 45% - 60% instead of 35% - 50%.

If you will be using after-tax figures, consider whether the federal or state income tax or self-employment tax should be adjusted for nonrecurring income/expenses or optional expenses you are adding back. If the income changes the taxes will change as well.

An NOL that has just been used up will no longer shelter income from taxes, also requiring an adjustment on your part to reflect projected taxes.

gLobAL CAshfLow

With closely-held companies, lenders commonly look at the business and the primary business owner as if they were one entity. Often the amount of compensation the owner pays herself is at the advice of the tax preparer to minimize taxes. By combining the analysis, the lender considers the strength of both the business and the owner/guarantors.




the six ‘ns’

historical or recurring..................................NoNtAxeD INCome/gAIN NoNDeDuCteD exPeNse/Loss NoNCAsh INCome or exPeNse

Missing piecesIncome not taxed

Income examples:Child support rec’dTax-exempt interestNon-taxed portion of SS,

IRA, pension

AGI Method:Add (Gross up?)

S/A Method:Add (Gross up?)

Missing piecesExpenses not deducted

Expense examples:Principal loan payments50% meals/entertainment

AGI Method:Add back interestSubtract full debt or put on

debt listSubtract 50% meals

S/A Method:Add back interestSubtract full debt or put on

debt listSubtract 50% meals

Tax-impact items that do not represent cash in or out

Income examples:IRA RolloversRoth IRA ConversionsPass-thru K-1 income/gains

Expense examples:Depreciation, amortization,

depletionCarryoversNet Operating Loss (NOL)Pass-thru K-1 expense/loss

AGI Method:Subtract noncash income/

gains if increased AGIAdd back noncash

expenses/losses if reduced AGI

S/A Method:Only subtract noncash

income or add back non-cash expenses if they have impacted a number you are using in cashflow such as Schedule C Net Profit

gross uP NoNtAxeD INCome

If you subtract federal income taxes do not use this idea.

This is a common technique to get all income included at its taxable equivalent. This is ONLY needed when you use a before-tax approach and your guidelines assume all income is taxed.

If you are not sure if your company allows this adjustment, ask first.

Consistently applied to child support, tax-exempt interest, untaxed disability, social security, pension and IRAs, you multiply nontaxed income by 1.25 which brings it up to taxable income if the borrower is in a 20% bracket.

Other factors:1.2 factor is 15% bracket1.6 factor is 39% bracket.Or calculate: 1/(1-tax rate).


LINDA KEITH, CPA


recurring (continued) ...................................New INCome/exPeNse NoNreCurrINg INCome/exPeNse NoNDoCumeNteD INCome

Missing piecesNew since tax return year

Income examples:New rentalNew jobNew business contract

Expense examples:New leaseNew alimony payments

AGI Method:Document first, then...Add income and subtract

expenses

S/A Method:Document first, then...Add income and subtract

expenses

They received it or spent it but we don’t think it will continue

Income examples:Alimony (maybe)Contract receivable (maybe)

Expense examples:Moving expenseDisaster repairsMerger costs

AGI Method:Add back expenses and

subtract income

S/A Method:Add back expenses and

subtract income if included in a figure you are using for cashflow such as Schedule C Net Profit

Otherwise, do not include

Income you do not need to qualify which would require additional questions or documentation

Income examples:Alimony received (maybe)Contract receivable (maybe)

AGI Method:Subtract non-documented

incomeIn comments, make note of

possible additional source of income

S/A Method:Subtract if it is included in

a number you are using in cashflow such as

Schedule C Net ProfitOtherwise, do not includeIn comments, make note of

possible additional source of income

the six ‘ns’

Net oPerAtINg Loss

These are carryforwards of losses related to business, work, casualty or theft. NOLs may be pass-throughs from a partnership or S corporation. They can be carried forward 15-20 years.

They are always noncash and in a 1040 are found on Page One, Line 21.

A statement showing the year it came from, how much was used each year and what is left is required.

If there is remaining NOL to carryforward, this may be a compensating factor. To the extent the borrower has an NOL, they are not paying taxes on some of their otherwise taxable income.




suggesteD ProCeDure for CAshfLow ANALysIs

This procedure will assist the lender in keeping track; help document the thought process, questions and judgment calls; provide a tool for selling the loan recommendation and enable senior lenders to evaluate.

1. ALWAYS USE A WORKSHEET!

2. PROCEED LINE-BY-LINE through the first page of the Form 1040. When you come to a line that is carried forward from another Form or Schedule, circle the number and go find it on its supporting schedule. Circle the number when you find it and be sure it is the number you are looking for. This ensures you have all of the schedules that support the front page of the return. Proceed line-by-line down that schedule, then return to the page from which you came.

3. FOR EACH ENTRY ON THE RETURN your choices are:

AGI METHOD ...no adjustment necessary. ...adjustment necessary and can be

determined with information available, enter on appropriate line of the cashflow worksheet.

...not sure, adjustment cannot be determined from information available or need additional documentation, enter on question sheet.

SCHEDULE ANALYSIS METHOD ...include in cashflow, enter on worksheet. ...do not include in cashflow, enter a zero

on worksheet and explain. ...need additional information or

documentation, enter on question sheet. ...if business or rental schedule, use

bottom-line income and see AGI method.

4. AFTER EACH FORM OR SCHEDULE has been reviewed take a look at the cashflow worksheet section for that form to see that you have considered all


LINDA KEITH, CPA


important items. Then put a check mark at the bottom of that page on the tax return and return to the source schedule or form.

5. IF THE TAXPAYER HAS INCOME FROM A CONTROLLED CORPORATION, PARTNERSHIP OR S CORPORATION and you are doing a personal analysis, use the 1040 as the master tax return and handle each source entity as it feeds into the 1040 (on the wage line for Corporations and Schedule E, Page 2 for Partnerships and S Corporations).

6. CONTINUE THROUGH PAGE TWO of Form 1040. (See page 2-15 for what to look for on the second page of the 1040).

When you are to the bottom of page two you should have reviewed every relevant page of the tax return. Confirm this by flipping through the pages and looking for your check mark at the bottom of each.

There are some pages that are not relevant to your cashflow analysis and will not have checkmarks on them. These include Alternative Minimum Tax forms and some additional schedules the preparer may include such as detailed equipment/depreciation lists.

7. RUN A TAPE of what you have so far and assumptions on the questions for the borrower. If there is no way they can qualify you may have enough information to decline the loan at this step. If they qualify already then perhaps you don’t need to ask all of the questions you had in mind.

8. RESOLVE QUESTIONS for the borrower, another lender or underwriter. Note the date and time you spoke with that person. If you are not confident of the questions you have for the borrower, run them by another lender first.

If you now decide that some of the questions you wrote down as you went are not needed, remove the questions or indicate they are not material. Do not

leave unanswered questions in the file.

9. MAKE ADDITIONAL ENTRIESin the worksheet if the answer you received from the borrower warrants it. SHOW ALL CALCULATIONS!

10. NOW ADD UP THE NUMBERS. Do they qualify?

11. IF YOU HAVE TO MAKE A JUDGE-MENT CALL calculate cashflow using the most conservative assumption. Make a note where you will notice it, however: IF MORE QUALIFYING INCOME IS NEEDED...

Only pursue the question if it makes a difference in whether the borrower will qualify. If you choose not to pursue a significant adjustment because it is not needed to qualify, make note of it in case you need it later or it should be considered in a future loan request.


ESSENTIALS AND 1040 REVIEW

1-14


Loan Request CheCkListLoAN request CheCKLIst

* The items with an asterisk will not always require additional documentation, depending on guidelines/procedure of your financial institution. If the income item is not needed to qualify then you may be able to forego additional documentation.

An example: Wages are sufficient to qualify your borrower so you choose not to get additional documentation regarding alimony received and interest received.

If you are unsure as to whether they qualify without it, consider requesting the documentation up front rather than to waste time and delay the loan request by having to go back to the borrower for more. On the other hand, once something is in your files you may have to consider it. Shredding probably is not an option!

Use your judgment and know your guidelines. The documentation indicated is my recommendation.

Wages W-2, Line 5Current pay stub

Most lenders use wages before optional 401K type deductions. If wages have increased dramatically at current job, is it from a promotion or nonrecurring bonuses/overtime?

Wages: Own Company

W-2Current pay stubTwo years Form 1120

Corporate or 1120S S Corporation Tax Return if borrower owns sufficient %

Recent Year-to-date Income Statement

Need to verify that a closely held corporation in which borrower is a high % owner is generating sufficient income to cover wages received. If wages are not enough to qualify, lender may give credit for additional funds generated by the corporation in some situations. The percentage ownership that triggers the requirement for the corporate return is a matter of guidelines. See manual on Beyond the 1040: Corp., partnership & LLCs.

Only verify interest/dividend income when significant in amount. The lender may use the application/Net Worth Statement to verify that assets are still held. Add tax exempt interest and nontaxed dividends if recurring. Gross up (see page 1-10) if guidelines allow. Will some of the assets be used for down payment of a mortgage loan? If receiving payments on a contract, use total received instead of interest.

Interest*Dividends*

Two years 1040Current Net Worth

StatementApplicationCopies of Notes/

Contracts

Alimony Received*

Copy of divorce decree2 years 1040Copies of Bank/CU

statements

Verify alimony received if necessary to qualify for the loan. If you are unsure, request documentation. Which of the documentation items and how many months statements depend on your guidelines.

Item: CommoN DoCumeNtAtIoN: CommeNts:


LINDA KEITH, CPA

Linda Keith CPA, Inc. January 20121040/V1


The consumer/mortgage lender will need to determine ongoing cashflow available to the borrower from the business. If not significant or hobby in nature, you might waive requirements for an updated financial statement and disregard the income/loss. The commercial lender recognizes the ‘profit ’ is also compensation to the owner and not all available to service debt.

Business/Farm Income: Sole Proprietor or One-owner LLC

2 years 1040Year-to-date Financial

Statements

Capital Gains*Capital Losses RE Contract Stock SalesRE Sales

1040 Tax ReturnsCopy of ContractCurrent Net Worth

Statement if Stock or RE sold

RE Closing StatementsStock Broker

Statements

If capital gains/losses are not significant, nonrecurring or are clearly not needed to qualify the borrower you can forego documentation. Many lenders prefer to use at least three years tax returns when relying on recurring capital gains. If the gain/loss is recurring and assets sold were not replaced (sell-off of stock or RE), lender should consider giving credit for net proceeds from sales, which will be different than taxable gain or loss. If a loss, it may camouflage positive cashflow in the current year depending on when the borrower paid for the item. If it is recurring income from an installment sale (note or contract receivable) include full payments in cashflow, not just gain and interest.

Use actual cashflow from the past two year ’s returns. If the property has not been held that long or was purchased since then, a formula is used. The Property Analysis Form will save time.

Rentals 1040 tax returnsSigned leasesComplete REO

Property Analysis form

IRA*Pension*Social Security*

1040 tax returns1099W-2P

Is this recurring or a one time lump-sum distribution? If recurring give credit for the entire amount received. (See page 1-10 regarding grossing up nontaxed portion.) If the IRA/Pension is reported on the total lines with none taxable, it is either a rollover (no adjustment/income) or a withdrawal from a Roth IRA. If no social security is taxable, it may not be reported at all. Use 1099 from SS for documentation.





Child Support* Divorce decreeEvidence of receipt

Your borrower does not need to give you this information if they do not need the child support to qualify. If the children are near 18 determine how long the child support will continue.

Other income* 2 years 1040Other documentation

Ask the borrower the nature of the income. Document recurring income necessary to qualify the borrower. Net Operating Losses (NOLs) are reported on the Other Income Line but do not reduce cashflow.

Estate/Trust* Estate or Trust Tax Return (1041) for two years

Trust document

Documentation is necessary only if the income reported on the tax return was actually received or could be received, is expected to continue (ask the borrower about both) and is needed to qualify for the loan. Trust income may appear to be consistent but may not be continuing ...ask.

S Corporation Income

1120S K-1Form 1120S

S Corporation Tax Return if owner owns sufficient %

Recent Year-to-date Financial Statements

The lender has to determine both the cashflow received by the owner and, with higher % owners, the owner’s share of cashflow generated by the S corporation. The number on Page Two of the 1040, Schedule E cannot be used for cashflow from the S corporation. See manual on Beyond the 1040: Corporation, partnership & LLC returns for details.

Partnership or LLC Income

1065 K-1Form 1065, Tax Return

if owner owns sufficient %

Recent Year-to-date Financial Statements

The lender has to determine both the cashflow received by the owner and, with higher % owners, the owner’s share of cashflow generated by the company. The number on Page Two of the 1040, Schedule E cannot be used for cashflow from the company. See manual on Beyond the 1040: Corporation, partnership & LLC returns for details.

Unemployment Compensation*

Two years 1040 Use as income and obtain documentation only if unemployment compensation is seasonal and recurring.


LINDA KEITH, CPA


Keogh/SEP*Contributions

None This may be a required or an optional contribution. If optional, it can be added back in the AGI method and ignored in the S/A method. If significant to the loan decision ask the borrower if it is optional. If the borrower is the only ‘employee’ of the sole proprietorship, it is functionally optional and may be able to add it back (AGI method) or ignore it (S/A method).

Alimony paidChild Support paid

Copy of divorce decree or legal separation

Alimony and child support paid may be counted against your borrower as part of the debt calculation or as an income reduction depending on the guidelines of your financial institution. Ask the borrower how long it will continue! If less than 6, 10 or 12 months (according to your guidelines) it may not have to be counted as debt or against income. You would need documentation to support this. I recommend it be treated as an income shift between households, and therefore subtracted from income rather than put on the debt list. This can make the difference in qualifying the borrower.


how the froNtLINe PersoNNeL CAN AssIst the CreDIt offICer IN obtAININg ADequAte DoCumeNtAtIoN: Go down through Page One and Two of the 1040 and trace the numbers to the appropriate schedules. Incomplete tax returns are often submitted which do not give the lender the information needed and slows down the loan process.

Compare rentals reported on the tax return to your application or the Real Estate Owned Property Analysis Form. The borrower may call a property the Tumwater Hill property on the application and 311 S. D Street on the tax return. The lender has to know which property is which to calculate qualifying income.

If a property is listed on the tax return but not on the application, verify with

the borrower that they no longer own the property. The sale may have resulted in additional cashflow if they held the contract or deposited it in your financial institution.

If the rental is on the application but not on the return, verify it was purchased since the tax return date and get required documentation, scheduled rents and payment (PITI) figures.

In some cases, you are knowledgeable about tax return analysis but are over your approval limit. By analyzing the return yourself and with your more complete knowledge of the borrower, you can get questions answered and additional information needed before you submit the package to the decision maker.




CAshfLow worKsheets

suggestIoNs 1) Before you start, take a quick look at the

loan request and the tax return to get an idea as to whether you will be digging for dollars or just doing the basics.

2) Use the tax return like a road map. Take it from the top and ‘detour ’ to supporting schedules as you go. No worksheet or software has everything that might be on a tax return or might need adjustment.

It is easier to keep track of where you are if you take the tax return in order. Use the worksheet as a reminder after you have reviewed the tax return schedule.

3) Use AGI Method Page One (opposite page) OR Schedule Analysis Method Page One (page 1-21), whichever best fits your company’s guidelines.

4) The worksheets in this section are designed for case study practice, with help notes included. These notes are available by positioning your ‘mouse’ over an item when using the Electronic Worksheet. Our eWorksheet has room for four years’ analysis.

CoPyrIght NotICe

All worksheets are copyright protected, of course. I have included a clean set of worksheets in the back of the manual which you may reproduce for use in your company as long as you leave my copyright notice on and do not alter it.

There are blank lines on each schedule of the worksheet to allow you to customize it for your guidelines. You may contact me each year and I’ll send you the update of the printed case study version.

You may not create a computer version of my worksheets for use in your own company or otherwise. I do this because I sell them ;-) and because I cannot take the chance of errors in preparing your version and I am not willing to have my work out there without my copyright protection.

Our eWorksheets are licensed for one PC or network user only and are designed to work with Excel™. If you do not have the eWorksheets, yours is out of date or others in your company need them, go to www.LindaKeithCPA.com to order and download.

The blank case study versions work for one year and include some of the help boxes. They start on page 6-3.


LINDA KEITH, CPA


AgI worKsheet

* From another worksheet.

Year: AGI 37

+/- Wage Adj 7

C-Corp Owner from w/s 1120 Tax Return *+/- Interest Adj 8a/Sch B

Add Full Note pmnts rec'd From clientAdd Tax-exempt 8b

+/- Dividends Adj 9/Sch BSubtract * State Tax 10+/- Alimony Adj 11Sch C Business from w/s 12/ Sch C *+/- Cap Gains (Loss) 13/Sch D

+/- Other Gains (Losses) 14/Form 4797+/- IRA Distributions 15+/- Pension Distributions 16Rents, Pships,etc

Subtract gains/add losses 17Rental C/F from w/s Sch E, Pg 1 *K-1 Summary Sch E, Pg 2 *Partnership C/F from w/s Sch E, Pg 2 *S Corp C/F from w/s Sch E, Pg 2 *Add * Estates/Trusts Sch E, Pg 2

Sch F Farm from /s 18/S h F *

Adjust the following only if needed to adjust to cashflow:

AGI: This is your starting point. 1) Every item that is already in AGI needs no further adjustment.2) For historical/actual cashflow:Add nontaxed income and noncash deductions.Subtract nondeducted expenses and noncash income.3) For projected/recurring cashflow:Add nontaxed or new income Add back noncash and nonrecurring deductions.Subtract nondeducted and new expenses, noncash and nonrecurring income. Also subtract nondocumented income.

Ln 7 Wages: Adjust to current per W-2 Line 5 or year-end paystub. ...

Ln 13 Capital Gains: Historical or recurring cashflow? Recurring or not? Stock or Real Estate? Check your guidelines and/or manual for treatment. ...

Ln 17 Rents, Partnerships, etc: 1) On the next line, subtract the gain or add back the loss listed on Line 17. This is an elimination step. 2) Replace it with expected cashflow from next 5 lines on w/s. ...

Sch F Farm from w/s 18/Sch F *Subtract * Unemp. Comp 19+/- Social Security 20+/- Other Income/NOL's 21Add Adjustments per guidelines 23-35Other Explain:

ie: AGI Add back All Adj.ie: 1/2 SE Taxie: minus Fed/State Taxie: minus Family Livingie: minus personal debt

Annual CashflowMonthly Cashflow

COMMENTS:

Ln 21 Other Income/NOL's: 1) Subtract nonrecurring income. 2) Add back Net Operating Loss. ...

CAUTION: Use either K-1 Summary OR cashflow from pass-through entities NOT both….

Comments: Explain calculations or source of figures. List income you did not include or document because you do not think it is needed to qualify for this loan.

Other/Adjustments: Most AGI lenders either add back 1/2 SE Tax and subtract total tax from page two, or make no adjustment for 1/2 SE tax. CHECK YOUR GUIDELINES!'Other' lines can be used to subtract federal/state tax, alimony/child support, family living, personal debt. Again...check your guidelines!


LINDA KEITH, CPA


sCheDuLe ANALysIs worKsheet

Year:Wages 7

C-Corp Owner from W/S 1120 Tax Return *Interest 8a/Sch B

Full Note pmnts rec'd from clientTax-exempt 8b

Dividends 9/Sch BState Tax 10Alimony Received 11Sch C Business from W/S 12/ Sch C *Capital Gains (Loss) 13/Sch D

Other Gains 14/Form 4797IRA Distributions 15Pension Distributions 16Rents, Pships,etc

Do not use. 17Rental C/F from W/S 17/Sch E, Pg 1 *K-1 Summary 17/Sch E, Pg 2 *Partnership C/F from w/s 17/Sch E, Pg 2 *S Corp C/F from W/S 17/Sch E, Pg 2 *Estates/Trusts 17/Sch E, Pg 2

Sch F Farm from W/S 18/Sch F *Unemployment Comp 19Social Security 20

* From another worksheetLn 7 Wages: Use current. Consider W-2 Line 5 or year-end paystub. ... NOTE: If your worksheets have a different place for wages not from self-employment (FannieMae) do not enter them here. ...

Ln 8 Interest: Check guidelines or see manual for treatment of contract and k-1 pass-thru interest. Schedule B is not required if taxable interest is less than $1,500. ...

Tax-exempt: Unless you subtract federal taxes, consider multiplying by 1.25 before you add any nontaxed income to cashflow. ...

Ln 13 Capital Gains: Actual or Projected? Recurring or Nonrecurring? Check guidelines for numbers to use and documentation required. Enter zero if not using to qualify.

Ln 17 Rents, Pships, etc: Ignore the gain or loss listed on Line 17. Enter cashflow from rentals, partnerships, s corporations, estates and trusts on the lines that follow.

y 20Other Income/NOL's 21Other Explain:

ie: minus 1/2 SE Taxie: minus Fed/State Taxie: minus Family Livingie: minus personal debt

Annual CashflowMonthly Cashflow

COMMENTS:

Ln 21 Other Income/NOL's: Actual: Enter income but do not include noncash NOL. Projecting: Enter zero if nonrecurring income or Net Operating Loss (NOL). ...

Other Explain: The following lines are available to make entries specific to your tax return analysis guidelines. Examples:Subtract 1/2 SE tax or Federal/State Income TaxSubtract personal debtSubtract child support/alimonySubtract family living expenses

Check your guidelines!

Comments: Explain calculations or numbers from other sources. List income you do not document and use because you do not need it to qualify.

CAUTION: Use either K-1 Summary OR cashflow from pass-through entities NOT both.


LINDA KEITH, CPA


questIoN sheet

Prepared by>>Spoke with & date:

Question #:Source of question:Question for whom:Question/Item:

Documentation needed:Response:










eworKsheets users: The eWorksheets provide for one Sole Proprietorship. If the borrower has more, the workbook can be ‘unprotected’ so that the worksheet can be copied for more. Be careful to adjust the formula on the front page or override it to take the cashflow adjustments from all Schedules C forward.

Debt CoverAge APProACh: If you decide to calculate debt coverage for a sole proprietorship, be sure first to subtract the owner’s withdrawal of capital which is how they pay themselves. After they are paid the remaining cashflow is available for debt service.


LINDA KEITH, CPA


sCheDuLe C: soLe ProPrIetorshIP worKsheet

1040 Schedule C Cashflow Worksheet

Business Name and Type>>>

Year>>>Net Profit (NOT AGI METHOD!!!) Line 31Add back noncash depreciation. Line 13Add back interest expense.* Line 16Subtract term debt.** BorrowerSubtract line of credit interest-only.** BorrowerSubtract proposed payments. BorrowerSubtract nondeducted meals Line 24bAdd noncash home office Line 30Optional: Subtract 20% Debt for 1.2 DCR

+/- Additional adjustments.

Total AGI Adjustments or S/A Cashflow

* FannieMae and many secondary-market mortgage lenders do not add back interest or subtract business debt.

Schedule Analysis Method: Enter Net ProfitAGI Method: Do not enter net profit. It is already in AGI.

Interest Expense: Add back to eliminate it. Then subtract loan payments below or enter them on the debt list for debt coverage ratio.

Term Debt: This information is not on the 1040 tax return. You must get the monthly debt payments from the borrower's application, credit report or other records.Be careful that you do not count a payment against the business here and count it on their personal debt list. One place or the other, not both.If you want to be sure that the amount of cashflow you carry forward to the personal analysis leaves adequate debt coverage in place, consider multiplying the annual debt payments X 1.2 or whatever debt coverage you need. This is most commonly done by commercial lenders. Check your guidelines.

LOC (Line of Credit): Line of Credit (LOC) interest-only payments are simply 'rent' on a

Comments:

** Subtract debt for net cashflows to owner. Omit debt if calculating debt coverage.CAUTION: Need Owner's Draws to calculate debt coverage.

y p y p yshort-term use of credit. 1) Three common methods a) Subtract annual interest-only payments.b) Subtract the annual interest payments that would occur if they borrow the entire available line and keep it out all year.c) Some financial institutions substitute assumed term debt payments for LOC interest only payments, especially if the LOC is not seasoned. Term outs over three to five years are common. ...

LOC (Line of Credit): Line of Credit (LOC) interest-only payments are simply ‘rent’ on a short-term use of credit. 1) Three common methods a) Subtract annual interest-only payments.b) Subtract the annual interest payments that would occur if they borrow the entire available line and keep it out all year.c) Some financial institutions substitute as-sumed term debt payments for LOC interest only payments, especially if the LOC is not seasoned. Term outs over three to five years are common. ...




eworKsheets users: When using the eWorksheets, be sure to scroll to the right to get to the previous year. If you put a 2009 rental right after the 2010 it will assume they are both 2010 rentals.


LINDA KEITH, CPA


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reAL estAte owNeD

ProPerty ANALysIs form

This is a handy form to gather the most current information on rentals and other real estate owned. If your borrower is involved in real estate investment or owns many rentals, I recommend this form be made part of the application process.

Enlarge it to 8 1/2” by 14” for easier use. You may also need to obtain signed leases depending on your loan guidelines.

You can then check here for new rentals, changes in rents charged and reduction or increase in loan payments. You also have the information necessary should you choose to use a formula for rental income instead of the tax return.


LINDA KEITH, CPA


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Present Combined Loan $

tax return analysis e and 1040 review - lender's online...

Documents