Green Legos 6 Ns A Map to Tax Return Analysis

Green Legos Six Ns and A Map to Tax Returns A guide to tax return analysis for bankers.

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Tax Return Analysis

Linda Keith I help lenders say “ Yes ” to good loans.

LEGO™ APPROACH To Tax Return Analysis

Picture a pile of Legos™, most of them green. Build something with them and you’ll have a model of the tax return.

Green Legos represent Recurring Cash Flow Why do we need green legos?

Taxable income is not necessarily cashflow

Cashflow is not necessarily taxable

Our job is to find recurring cashflow

Examples of Recurring Cashflow Wages ◘ Rentals ◘ Capital Gains ◘ Child Support ◘ Business

BLUE Legos represent Noncash items Why do we need to find and get rid of blue legos? Noncash items do not impact the borrower’s ability to pay debt.

Depreciation Carryovers Net Operating Losses K-1 Pass-throughs Noncash Examples No one wrote a check for these items!

Yellow Legos represent Nonrecurring items Why do we need to find and get rid of yellow legos?

If you are looking for recurring cashflow, income not usually available won’t pay debt.

If you are looking for recurring cashflow, expenses they do not usually incur won’t reduce future ability to pay debts.

Capital Gains? Alimony? Contract Receivable? Insurance Proceeds? Examples of Nonrecurring Income Why question marks? These may or may not be recurring. Check.

Lawsuit settlement

Flood repairs

Start-up costs

Nonrecurring Expenses Look harder for nonrecurring expenses when you are digging for dollars!

Red Legos represent Red Flags Why do we need to find and resolve red legos? If the deal does not make sense or the numbers make you nervous, you could be looking at fraudulent statements or a business getting into trouble. Even if you aren’t worried, you need to recognize what will worry the underwriters or loan review. Get those questions resolved and you have a better chance of making the loan. Or if is not a good loan, move on to the next opportunity!

Inadequate taxes Settlement Fees Red Flags If something doesn’t look right, pick up the phone and call the borrower.

Let’s face it, sometimes it is a mystery.

If it is income…

Is it needed to qualify?

Is it needed for best pricing?

If you cannot tell by looking what color the lego is…here is how to decide whether to pursue it.

If yes…

Check other years

Ask borrower

Let’s face it, sometimes it is a mystery.

If it is outgo…

Is an addback needed to qualify?

Is an addback needed for best pricing?

If you cannot tell by looking what color the lego is…here is how to decide whether to pursue it.

If yes…

Check other years

Ask borrower

Recurring Cashflow Use the green lego approach. You’ll start with this…

Recurring Cashflow And end with this…

FOR ANY TAX RETURN 6 Ns From Taxable Income to Cashflow

Some bankers just LOVE the Green Lego Idea.

Others think I must be NUTS! Well, maybe so….

From taxable income to recurring cashflow to pay debt I long ago learned that there is more than one way to explain the same thing. Comes in handy in my tax return analysis training and webclasses. So let’s try the 6 Ns.

To get to Historical Cashflow Start with taxable income… Add nontaxed income Subtract nondeducted expenses Add back noncash expenses

To get to Recurring Cashflow Start with historical cashflow… Add new income Subtract nonrecurring income or Add back nonrecurring expenses Subtract nondocumented income

Nontaxed income

Child support and Tax-exempt interest

Untaxed portion of social security, pensions, IRAs

Nondeducted expenses/losses

50% meals and entertainment

Excess capital losses

Noncash expenses

Depreciation, amortization, depletion

Net Operating Losses and Carryovers

New income or expenses

New rental, business contract or job

This could be anything

Nonrecurring income or expenses

Insurance proceeds or legal settlement fees received

Disaster repairs, alimony paid, charitable contributions

Nondocumented income

Child support received, alimony, notes/contracts receivable

This could be any income that you do not need to qualify the borrower

A few examples of each:

CANADA TO MEXICO The Road Trip Method

Take the direct route. Which one of these pictures looks like you at work?

Or is it this one?

Imagine you are headed from Vancouver, British Columbia to Tijuana, Mexico and time is short… You won’t visit the Space Needle, then Yosemite National Park, then the Oregon Coast, Fisherman’s Wharf in San Francisco, back up to the home of the Appaloosa Stallions, on to Hollywood and then to Mexico.

This is more like it!

Start at the top of the return. Work your way down, step by step!

When you get to a line that comes from somewhere else, circle it and trace it to the source. In this case, Schedule B.

Take the detour to Schedule B and review that schedule for adjustments or questions. I circle the number on page one to show I traced it. Then I circle the total on the supporting schedule to show I checked that it is the same as the number on the front.

When you are done with that schedule, put a checkmark to show you are … then back to page one and continue down the main highway.

Whenever you get interrupted by a phone call or meeting, draw a line where you are. It will be easy to pick it back up after the interruption.

For Historical:

Nontaxed

Nondeducted

Noncash

Recurring…

Continue with

Nonrecurring

New

Nondocumented

Works for Historical or Recurring Cashflow Start in Canada and head to Mexico Find the GREEN Legos

Congratulations You have successfully completed Tax Return Analysis Green Legos, Six Ns and a Map Presented by Linda Keith CPA

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