2016 Lenders Tax Analyzer Users Update - Part 1

Transcription

1 2016 Lenders Tax Analyzer Users Update - Part 1 Form 1040, Interest, Dividends, Sole Proprietorship, Capital Gains, Other Gains Timothy Harrington, CPA THarrington@forTeamResources.com

2 Presented by Timothy Harrington, CPA Tim Harrington is a Certified Public Accountant who has taught lending personnel how to make good loans since Since 1996, Tim has been President of TEAM Resources, a firm that provides consulting, strategic planning and training to financial institutions from coast-tocoast. He is the author of the popular lending software Lenders Tax Analyzer and the book Eisenhower on Enlightened Leadership. Tim is a faculty member of two national financial professional schools on finance and management, and has spoken to tens of thousands of consumer, mortgage and commercial lending personnel throughout the US. 2

3 Lenders Tax Analyzer Main Menu 3

4 Begin Select which tax year you want to input and click here Screen Size You can enlarge and shrink the input screen using the Zoom choices here 4

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6 Moving Around To move from input sheet to input sheet, you can click here Or here - 6

7 What are you looking for in a tax return? 1. How much cash is borrower really earning! 2. What is the earnings trend (2 or 3 years) 3. Is the income recurring? Get the whole return. 7

8 Schedule D and Form 4797 Sales/Capital Gains Schedule C Sole Proprietorship Schedule B Investment Income (Interest & Dividends) Form 1040 Individual Income Tax Return Tax Exempt Interest Divorce Income Tax Refunds Pension Income Unemployment Compensation Social Security Other Income Schedule E, Page 1 Rental/Royalty Income Schedule E, Page 2 Partnership & S Corp Schedule F Farm Income 8

9 Form 1040 The Keystone Focus on this part of the form Lines 7 through 21 9

10 Taxable interest and dividends: We will cover this on Schedule B We only concern ourselves with Ordinary Dividends. Qualified Dividends are included in Ordinary Dividends. So ignore Qualified Dividends 10

11 Tax-exempt interest is NOT taxed and NOT included in taxable income by IRS. But for us, it is extra qualifying income. WE ADD IT. 11

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13 Tax-exempt interest is tax free. Consider grossing up the tax free portion. 13

14 Grossing-Up Income If you use "Gross Income" to qualify a borrower, their Non-Taxed Income has more spending power than taxed Income. To make these incomes more comparable, you may want to Gross-Up the borrower s Non-Taxed Income. Each organization has its own policies on "Grossing-Up" Non-Taxed Income. It is best to use the borrower s effective income tax rate. (calculated by dividing the Total Tax by the Taxable Income.) Some financial institutions use a standard percentage of 20%, 25%, or 30%. Example: Tax Exempt Interest Income $2,100 Gross up Percentage 25% $ 525 Grossed-up income $2,625 $2,100 worth of Tax Exempt Interest Income has similar spending power to $ 2,625 in Taxed Income 14

15 The effective tax rate is determined by dividing the Total Tax into the Taxable Income. Use the resulting percentage to gross up the borrower s tax exempt income. E.G: Taxable Income $50,000 Total Tax $12,500 Effective Tax Rate $12,500/$50,000 X 100 = 25% 15

16 Taxable refunds are not an income and are always ignored. 16

17 Include Alimony if continuing AND being paid. If not, ignore. See following screen for other divorce incomes that might be additional qualifying incomes. 17

18 Other Divorce Incomes You Might Add The following incomes are not taxable but are real cash flows. Since they are not taxable, they are not found on the tax return. In your judgment*, if this income will last long enough and is in fact being received, you may add: Child Support Separate Maintenance Income Division of Assets: amount paid by one former spouse to other former spouse for value of asset that could not be physically divided (a house for instance) * You may have a policy on when to include 18

19 Sole Proprietorship Income: from Schedule C. We ll get to this later 19

20 Line 13: Capital Gains and Losses Line 14: Other Gains & Losses Form 4797 We ll get to these later 20

21 Retirement incomes: lines 15, 16, and 20. Each of these may have an untaxed amount. If the a box is higher than the b box, use the amount in the a box. 21

22 Exception: Rollover of IRA account If the a box is a rollover, use the b box. A rollover is not income in this year. Rollover 22

23 Rental, Royalty, Partnership, S Corp, Farm Lines 17 and 18: We ll get to these next class 23

24 Unemployment compensation: if it is recurring, add it. If not recurring, ignore it. Seasonal occupations may have recurring $ 24

25 Other income: Determine if the income is recurring. If so, keep it. Otherwise ignore it. NOL is an exception. See the next slide. 25

26 NOL = Net Operating Loss Carryover. This is a carryover to this tax return from some other tax year. It is NOT a cash flow this year. Always ignore it. 26

27 With no adjustments, this would be borrower s monthly income. (But there ARE adjustments) $105,991/12 = $8,833 per month 27

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29 Top Half of Worksheet - 29

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31 FORM 1040 Incomes Wages.. Get via current pay info Interest income If recurring, add it If non-recurring, ignore (see Schedule B) Tax exempt interest If recurring, add it If non-recurring, ignore Dividends. If recurring, add it If non-recurring, ignore (see Schedule B) Taxable refunds.. Always ignore Alimony. If recurring, add it If non-recurring, ignore it Other divorce income. Add if recurring (not found on return) 31

32 FORM 1040 Likely Incomes IRA distributions Add Total amount, NOT Taxable Pension distributions Add Total amount, NOT Taxable Unemployment Comp..If recurring, add it ignore If non-recurring, Social security. Add Total amount, NOT Taxable Other income.watch FOR: Net Operating Loss (NOL) carryover..ignore Income that won't recur....ignore Income that will recur.add Expenses from Form 2106.Subtract Expenses for Alimony Paid Subtract (possibly) 32

33 Taxable interest and dividends: We will cover this on Schedule B We only concern ourselves with Ordinary Dividends. Qualified Dividends are included in Ordinary Dividends. So ignore Qualified Dividends 33

34 Schedule B Interest and Dividend Income

35 If you see any Interest Income here that has come from a K-1 (partnership or S Corp), IGNORE that income. It is Phantom Income to the individual. Are these amounts going to recur in the future? If yes, then add. If not, ignore. 35

36 Chevron stock was sold this tax year If you see any Dividend Income here that has come from a K-1 (partnership or S Corp), IGNORE that income. It is Phantom Income to the individual. Are these amounts going to recur in the future? If yes, then add. If not, ignore

37 Chevron stock was sold 37

38 Schedule B Interest and Dividend Income Interest income that will recur: Interest income that won t recur: Interest income from K-1: Dividend income that will recur: Add Ignore Ignore Add Dividend income that won t recur: Ignore Dividend income from K-1: Ignore 38

39 Types of Business Entities Sole Proprietorship Schedule C on 1040 Partnership 1065 (Ask for K-1) Corporation 1120 S Corporation 1120S (Ask for K-1, may be useful, may not) Limited Liability Partnership (LLP) 1065 Taxed just like a partnership (K-1) Limited Liability Company (LLC) Depends Taxed on form for a partnership, or sole proprietorship, or an S Corp 39

40 How Income Comes Out of a Sole Proprietorship Sole Proprietorship The owner and the business are inseparable. The person is the business and the business is the person. Business pays taxes through the personal tax return Form 1040, Schedule C The Cash Flow from Schedule C is considered income to the lender 40

41 Sole Proprietorship Income: from Schedule C. We re looking for Net Cash Flow from Sched C 41

42 Schedule C Sole Proprietor Business Income This amount should tie to page 1, Line 12 If not, there is an error, OR there is more than one Schedule C 42

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44 Depletion, Depreciation, or Amortization: These are always added back. 44

45 SCHEDULE C Depreciation, Depletion or Amortization Add-Back Always These all represent non-cash expenses that are deducted from taxable income, but DO NOT reduce the borrower s cash flow. Depreciation and amortization represent the gradual wearing out of some asset you have purchased. The business is allowed to write off the cost of the asset little by little over the years as it wears out. Depletion is the using up of a natural resource, like gravel or oil. 45

46 SCHEDULE C Calculating Debt Service We add back depreciation this has no link to cash flow What does have a link to cash flow? If they borrowed money to purchase the asset, Principal and Interest will have been paid out resulting in negative cash flow We have to do something with the Principal in Interest We will calculate EBIDA (earnings before Interest, Deprecation, and Amortization) 46

47 SCHEDULE C Calculating Debt Service On a Schedule C, calculate Earnings before Interest, Deprecation, and Amortization: Add back Interest Expense Make sure the related payment (principal and interest) is picked up in the Debts (Debt Service) Add back Depreciation 47

48 Delivery Truck You could calculate Principal if you want $32,000 Loan Term: 48 $700/mo P & I Annual cost: $8,400 Interest: $2,500 Principal: $5,900 48

49 Borrower s Payments per Application Home mortgage $1,700 Auto loan 400 Credit card 200 Subtotal $2,300 Delivery truck payment 700 Total payments $3,000 49

50 With no adjustments, this would be borrower s monthly income. (But there ARE adjustments) $105,991/12 = $8,833 per month 50

51 Without adjustment: Home mortgage $1700 Auto loan 400 Credit card 200 Subtotal $2300 Delivery truck payment 700 Total payments $3000 Monthly payments = $3,000 Monthly income = $8,833 Effect of Payment on both sides $700 Payment Include w/ other pmts Interest expense on return reduces income Debt ratio: 34% EBIDA Interest Add Back Method Monthly payments = $3,000 Monthly income = $9,333 Subtract Principal Method Monthly payments = $2,300 Monthly income = $8,633 Home mortgage $1700 Auto loan 400 Credit card 200 Total $2300 Include Payment w/other payments Remove Payment Add back Interest & Deprec. Let interest stay on return as a deduction and Subtract Principal Debt ratio: 32% Debt ratio: 27% 51

52 Car and truck expense MAY HAVE some deprecation hidden here 52

53 SCHEDULE C Car and Truck Expense (line 9) You MAY be able to add back 44% of the Car and Truck expense reported on this line If the borrower used the Standard Mileage Method (SMM) ONLY add back if the borrower used the Standard Mileage Method The Standard Mileage Method allows the taxpayer to deduct an amount based on business miles driven during the year times so many cents per mile. We suggest using about 40% to 44% of the amount on line 9. The ratio fluctuates from year to year but was 44% in 2016 If the SMM was used! Ask borrower, Did you use the actual expense method or the Standard Mileage Method? If they used the mileage method, you may add 40% of the amount on line 9 as additional cash flow. If you aren t sure of if borrower used the Standard Mileage Method, DO NOT add any depreciation back to line 9. Simply ignore line 9. 53

54 Car and Truck Expense (line 9) Standard Mileage Rates If you would like to be more precise, following are the percentages of the mileage method you may consider adding back: In 2016, about 44% is considered depreciation (24 cents out of 54 cents) In 2015, about 42% is considered depreciation (24 cents out of 57.5 cents) In 2014, about 39% is considered depreciation (22 cents out of 56 cents) Example: Car and Truck Expense: $ 350 Multiply by Depreciation % x 44% Hidden Depreciation to Add Back = $

55 If Part IV is completed, the taxpayer PROBABLY used the Standard Mileage Method for determining Car and Truck Expense. If that is the case, then you would want to take a percentage of the amount on line 9 of page 1 as depreciation. But the best way to know if a borrower used the Standard Mileage Method is to ask the borrower of the borrower s tax preparer. 55

56 SCHEDULE C Car and Truck Expense (line 9) If Part IV is completed, the taxpayer PROBABLY used the Standard Mileage Method for determining Car and Truck Expense. If that is the case, then you would want to take a percentage of the amount on line 9 of page 1 as depreciation. 56

57 IRS only allows deduction of 50% of amount actually spent (shown here). We want to subtract the other 50%. So subtract $1,552 again. 57

58 SCHEDULE C Meals and Entertainment Expense (line 24) The IRS only allows ½ (50%) of Meal and Entertainment expenses to be deducted on the tax return Therefore, we calculate the other ½ and subtract it. Why? We assume that the full amount was actually spent, namely, the cash was paid out by our borrower, so even if it will not help them show a lower income for tax purposes, we want to lower their income by the disallowed portion. Subtract the same amount that is already reported on line 24 b 58

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60 SCHEDULE C Sole Proprietorship Depletion Always add back Depreciation.. Always add back Amortization.. Always add back Watch for depreciation hidden in Car & Truck expense Interest expense.. Don't double hit borrower. Use EBIDA (Interest Add Back Method) and include payment on Debt side of D/I ratio Non-deductible meal and entertainment expense. Subtract Office in Home. Probably add back 60

61 Line 13: Capital Gains and Losses Line 14: Other Gains & Losses Form 4797 We ll get to these later 61

62 SCHEDULE D Capital Gains or Losses Capital gains and losses are USUALLY from ONE TIME SALES and will not have an effect on future earnings (not recurring). Capital gains and losses are typically ignored (not used) If the borrower has gains or losses each tax year, the gain or losses may be recurring, if so: consider including the gain or subtracting the loss You must look at the borrower s past tax history and probably discuss with the borrower about the future 62

63 Schedule D Capital Gains and Losses Gains and losses from the sale of something Usually ignore!!! Only include Recurring gains! 63

64 Bottom Half of Schedule D If item sold is held one year or less it will be reported in Part I. Your questions should be: 1. What is it from? 2. Is it recurring? 3. Are there other sales in Part II or on Form 4797? This Gain may be a recurring Cash Flow If it is from Form 6252, it is probably recurring. Ignore other forms 64

65 Top Half of Schedule D If item sold is held one year or less it will be reported in Part I. Your questions should be: 1. What is it from? 2. Is it recurring? 3. Are there other sales in Part II or on Form 4797? If it is from Form 6252, it is probably recurring. Ignore other forms 65

66 Only include Capital Gains and Sales of Capital Assets if they recur 66

67 SCHEDULE D Capital Gains or Losses These gains and losses are USUALLY ONE TIME SALES and will not have an effect on future earnings (not recurring), therefore, we act as if they never occurred by IGNORING them. Gains or losses: (short-term or long-term) Gains:.. Usually ignore Losses: Usually ignore HOWEVER: If it the gain or loss is recurring, consider adding the gain or loss to your analysis. Look at the borrower s history. 67

68 Bottom Half of Schedule D If gain is from Form 6252, it is probably recurring. Ignore other forms 68

69 FORM 6252 Gain or Loss from Installment Sales If recurring, add this. Line 22 These are gains or losses that are likely recurring This amount passes through to Sched D, but we ignore it and pick up line 22 instead If recurring, add this 69

70 If recurring, add Line 22. This is the actual cash flow from PRINCIPAL received from this sale. Interest received shows up on Sched B 70

71 Zero here, because the gain from sale of stock was NOT recurring But there was in Installment Sale and the full amount of Principal received is added here. 71

72 09-07 FORM

73 FORM 6252: Installment Sale Income FORM 4797: Sale of Business Property These may show gains or losses that are recurring: Installment sale: USUALLY RECURRING. Add the gain or loss as cash flow if the term of the installment sale agreement will continue for a while longer. ASK! How much longer will you be receiving installment sale income? Ask to see the Installment Sale Agreement if need be. 73

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75 Top Half of Worksheet - 75

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77 Lenders Tax Analyzer 77

78 Print commands You can print any year by itself, all three years, or a Multi-Year that will average the monthly incomes for you Clear command This command erases all your input and readies LTA for a new borrower Help Online Whenever you are stuck, press Help and it will bring you to an on-line Help page and Manual 78

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80 Thanks for Attending! TIM Transform Inspire Motivate Timothy Harrington, CPA President