How to Use Tax Returns for Global Cash Flow with Multiple Pass-Through Entities

1. Use Tax Returns for Global Cash Flow with Multiple Pass-Through Entities

2. Questions + A copy of the slides and webinar recording will be emailed to you following the webinar + To ask a question during the webinar, enter it into the chat box in the GoToWebinar panel on right side of screen + Ask questions at any time + Questions we do not answer during the webinar will be answered individually afterwards.

3. About Sageworks + Financial information company that provides credit and risk management solutions to financial institutions + Data and applications used by thousands of financial institutions and accounting firms across North America + Awards + Named to Inc. 500 list of fastest growing privately held companies in the U.S. + Named to Deloitte’s Technology Fast 500 + NC Tech Awards: Excellence in Customer Service

4. About Linda Keith CPA + She provides credit training to financial institutions throughout the country with a focus on Tax Return Analysis and Financial Statement Analysis + Linda is an expert in Business & AgLending, Lending to the Wealthy & other Complex borrowers + She trains in both in-person and virtual formats and for in-house or open-enrollment audiences + Linda’s Sageworks Webinars are the most forwarded and have the highest attendance of our Credit Analysis Topics.

5. Please chat in your hot buttons on global cashflow. © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 5 My plan for the webinar: • Compare notes with others through polls • Consider your Guidelines and take back a list • Watch me walk-through three cashflow scenarios: • Entity-only Cashflow with Margin and DCR approach • Global Cashflow (Business and Personal focus) • Owner Cashflow (3 ways) • Ask questions My HOT buttons are: • Double Counting by mixing up taxable income, actual cashflow and cashflow available. (I guess that could be triple-counting!) • Using 1040 Schedule E, Page Two figures for pass-through entities • Using a formulaic, numbers-only approach without adding judgment

6. Who is your borrower? © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 6

7. B&J Floors Jan owns 25% Ben owns 67% Zac owns 8% © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 7

8. Poll Question 1 What type of loans do you and your team typically make? ( Choose all that apply) 1. Business (C&I) 2. Business (CRE) 3. AgLending – Production 4. Mortgage Lending 5. Consumer – Direct or Indirect © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 8

9. Poll Question 2 What is your role? ( Choose one) 1. Loan Officer or Business Development Officer 2. Credit Analyst/Underwriter 3. Lending or Credit Manager 4. Senior Lending Officer 5. Something else © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 9

10. Ben owns 67% Zac owns 8% © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 10 B&J Floors Jan owns 25%

11. Poll Question 3 Business Lenders…who will guarantee your loan? (Check all that apply) 1. 65% owner Ben 2. 25% owner Zoe 3. 10% owner Zac 4. All owners regardless of % 5. It depends on something else © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 11 Note the results on your handouts for later comparison.

12. Ben owns 67% Zac owns 8%   © Linda Keith CPA Inc Mar 2015 | 12 B&J Floors Jan owns 25%

14. 1120S 1040 1040 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks.htm | 14

15. 1120S 10401040 Jan owns 25% of B&J Floors Inc Jan owns 100% of Odds N Ends Medical Clinic Inc 1120S 1120S K-1OR OR 1120S 1120S K-1 © Linda Keith CPA Inc Mar 2015 | 15

16. Poll Question 4 Assume you are lending to B&J Floors and require a guarantee from Jan. What returns do your guidelines require? (Pick one.) 1. Odds N Ends 1120S 2. Jan’s K-1 from Odds N Ends 1120S 3. Both the Odds N Ends 1120S & the K-1 4. It depends…it might go either way. 5. I do not do business lending © Linda Keith CPA Inc Mar 2015| Resources at www.lindakeithcpa.com/sageworks.htm | 16

18. 1120S 10401040 Jan owns 100% of Odds N Ends Medical Clinic Inc 1120S 1120S K-1OR OR 1120S 1120S K-1 Hubby Dan owns 90% of Valley Vineyards LLC Dan owns 10% of Donut Shop 1065 1065 K-1OR OR 1065 1065 K-1 1120S K-1 | 18

19. Poll Question 5 You are lending to B&J Floors and requiring a guarantee from Jan who is married to Dan. What additional returns do you need? (Pick one.) 1. Valley Vineyards 1065 and Donut K-1 2. Valley Vineyards K-1 and Donut K-1 3. Valley Vineyards 1065 & the K-1 from both 4. None of these choices 5. I do not do business lending © Linda Keith CPA Inc Mar 2015| Resources at www.lindakeithcpa.com/sageworks.htm | 19

20. 1120S Jan owns 100% of Odds N Ends Medical Clinic Inc 1120S 1120S K-1OR OR 1120S 1120S K-1 Hubby Dan owns 90% of Valley Vineyards LLC Dan owns 10% of Donut Shop 1065 1065 K-1OR OR 1065 1065 K-1 1120S K-1 10401040

21. B&J Floors: Borrower Ben 67% Jan 25% 100% Odds N Ends Medical Dan: 90% Valley Vineyards Dan: 10% Donut Shop Zac 8% © Linda Keith CPA Inc Mar 2015 | 21

22. 1065 K-1 1120S K-1 B&J Floors: Borrower Ben 67% Jan 25% 100% Odds N Ends Medical Dan: 90% Valley Vineyards Dan: 10% Donut Shop Zac 8% 1120S 1040 1040 1120S Other Options: 1040 1065 1120S K-1 © Linda Keith CPA Inc Mar 2015 | 22

23. B&J Floors: Borrower Ben 67% Jan 25% 100% Odds N Ends Medical Dan: 90% Valley Vineyards Dan: 10% Donut Shop Zac 8% 1040 1065 1065 K-1 1120S K-1 1040 1120S 1040 1120S 1120S K-1 © Linda Keith CPA Inc Mar 2015 | 23

24. Jan and Dan Borrower Jan: 25% B&J Floors Jan: 100% Odds N Ends Medical Dan: 90% Valley Vineyards Dan: 10% Donut Shop 1040 1065 1065 K-1 1120S K-1 1120S 1120S 1120S K-1 1120S K-1 © Linda Keith CPA Inc Mar 2015 | 24

28. It all starts with the Entity Return Income Passes Through to the Owner 28

29. 1065 Information only K-1 1040 A B D E Pass-throughs K-1 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 29

30. Business Income is subject to Social Security Tax. 1065 K-1 1040 A B D E Pass-throughs Charitable contributions Example: Net Capital Losses limited to $3,000. K-1 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 30

31. 1065 K-1K-1 1040 A B D E Charitable contributions Actual Cashflow to Partner: Guaranteed Pmnts + Distributions – Capital Cont Also consider rents, loans or loan repayments. Cashflow Available to Partner: Use partner’s share of 1065 cashflow plus his/her Guaranteed Payments. Use K-1. © Linda Keith CPA Inc Mar 2015 | 31

32. 1120S K-1K-1 1040 A B D E Charitable contributions Actual Cashflow to Owner: And consider rents, loans or repayments to the owners. Cashflow Available to Sharholder: Use partner’s share of 1120S cashflow plus his/her Wages. Use K-1 Distributions. © Linda Keith CPA Inc Mar 2015 | 32

33. Entity-Level Analysis of a Pass- Through for Business Loan Goal: Cashflow Available to Pay Debt using DCR or Margin/Deficit Guideline/Procedure Questions: • What is our guideline for DCR or Margin? • Do we worry about a deficit or low DCR before doing the global? Global Analysis of a Pass-Through for Business Loan Goal: Cashflow Available to Pay Debt using DCR or Margin/Deficit Guideline/Procedure Questions: • Who will guarantee? • If I do not require all owners to guarantee, how to I get an accurate DCR? • What if a guarantor is an owner in another pass-through? • For DCR analysis, what will I use for family living expense? © Linda Keith CPA Inc Mar 2015 | 33

34. Poll Question 6 What is your approach regarding DCR? 1. We have a guideline at the entity level 2. We have a guideline at the global level 3. We use DCR but do not have a guideline 4. We do business loans but do not use DCR 5. This question does not apply to me © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 34

37. Poll Question 7 When calculating DCR for Global CF, what do you use to estimate family living expenses? (Choose all that apply) 1. General guidelines or number in the home 2. Lifestyle of borrower (boats, planes, hobbies) 3. What it takes to make the loan work 4. AgLenders: Live on-farm or off-farm 5. This question does not apply to me © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 37

38. Owner Analysis of a Pass-Through for a Personal Loan Goal: Cashflow from the Entity to the Owner Guideline/Procedure Questions: How do I decide between actual and available cashflow? Do I ever use Schedule E, Page 2 taxable income/loss? Guarantor Analysis of a Pass-Through for a Business Loan Goal: Cashflow from the Entity to the Owner Guideline/Procedure Questions: How do I decide between actual and available cashflow? Do I ever use Schedule E, Page 2 taxable income/loss? EntityK-1 1065 K-1 1040 E Taxable Income © Linda Keith CPA Inc Mar 2015 | 38

39. Poll Question 8 When do you use taxable income from 1040 Schedule E, Page 2 for owner/guarantor?(Choose all that apply) 1. When the pass-through entity is not obligated 2. When the owner has a low % ownership 3. When it is on the passive (left) side 4. I always do 5. Rarely or never © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 39

40. © 2013 Fiserv, Inc. or its affiliates. Questions on deciding between actual and available cashflow for owner/guarantor analysis? © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 40

41. © 2013 Fiserv, Inc. or its affiliates. Contact Information & Additional Resources Resources + 20 Video Series on Pass-Through Entities + Recordings of and resources from this and previous Sageworks Webinars + Global Tax Return Analysis Quick Reference Guide + Red Flags and Green Lights in Tax Returns: Extended Handouts © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 41

42. Owner Cashflow Actually Paid What happened in the checkbook? © Linda Keith CPA Inc Mar 2015 | 42

43. Source +/- Item Amount 1065 Box L or 19 (Code A) PLUS Withdrawals 1065 Line 4 PLUS Guaranteed Payments 1065 Box L MINUS Capital Contributed 1120S 16 (Code D) PLUS Distributions 1120S 16 (Code E) PLUS Repayments on Loans Equals Cash Paid to Owner Owner Actual Cashflow from a pass-through K-1 When you use this: • You are lending to the owner of a pass-through • You are calculating cashflow to a guarantor from another pass-through entity © Linda Keith CPA Inc Mar 2015 | 43

44. Poll Question 9 What cashflow from the business will you use for personal cashflow?(Choose all that apply) 1. Rents paid to the owner 2. Loans made to the owner 3. Repayment of a loan from the owner 4. Payment on a note payable to the spouse 5. Distributions and guaranteed payments © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 44 Assume all have been recurring sources.

45. Guideline Question © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 45

46. Actual Personal Cashflow Source +/- Item Amount 1065 Box L or 19 (Code A) PLUS Withdrawals $25,910 1065 Line 4 PLUS Guaranteed Payments 30,000 1065 Box L MINUS Capital Contributed -0- 1120S 16 (Code D) PLUS Distributions 1120S 16 (Code E) PLUS Repayments on Loans Equals Cash Paid to Owner $55,910 © Linda Keith CPA Inc Mar 2015 | 46

47. Handout Page 3 1120S K-1 © Linda Keith CPA Inc Mar 2015 | 47

48. 1120S K-1 Source +/- Item Amount 1065 Box L or 19 (Code A) PLUS Withdrawals 1065 Line 4 PLUS Guaranteed Payments 1065 Box L MINUS Capital Contributed 1120S 16 (Code D) PLUS Distributions 13,914 1120S 16 (Code E) PLUS Repayments on Loans Equals Cash Paid to Owner $13,914 © Linda Keith CPA Inc Mar 2015 | 48

50. What can the company afford? To cover debt or pay the owners © Linda Keith CPA Inc Mar 2015 | 50

51. $40,000 is the guaranteed payments to ALL partners. Form 1065 Page One 40,000 51

52. Form 1065 Page OneOwners pay taxes on both guaranteed payments and ordinary business income. 65,961 52

53. Form 1065 Page One 65,961 Bottoms Up Analysis +/- Item Amount 1065 Line 22 PLUS Taxable Income $65,961 1065 Line 15 Add Interest Expense 1,451 1065 16a Add Depreciation 1,174 K (various lines) PLUS or Minus Interest, Rentals etc 150 M-1 (various lines) PLUS or Minus Disallowed meals, etc -135 Equals Cash Available to Pay Debt and distributions to owners $68,601 53

54. Form 1065 Page One Top Down Analysis +/- Item Amount 1065 Line 1 - 8 PLUS Revenue $207,139 1065 Line 21 Minus Expenses -141,178 K (various lines) PLUS or Minus Interest, Rentals etc 150 M-1 (various lines) PLUS or Minus Disallowed meals, etc -135 Net Profit $65,976 1065 15 Add Interest Expense 1,451 1065 16a Add Depreciation 1,174 Cash Available to Pay Debt and distributions to owners $68,601 54

55. Form 1065 Page One Net Profit $65,976 1065 15 Add Interest Expense 1,451 1065 16a Add Depreciation 1,174 Cash Available to Pay Debt and distributions to owners $68,601 Cashflow Available to pay Debt Cashflow Available to Pay Debt 68,601 Available $68,601 Distributions Available for Debt Debt Margin DCR 51,820 51,820 16,781 16,781 14,451 14,451 $2,330 1.17 ©LindaKeithCPAIncMar2015|55

56. Poll Question 10 If you calculate DCR, what are you looking for? (Choose all that apply) 1. 1.25 or less 2. More than 1.25 3. It depends on why it is low 4. It depends on loan-to-value 5. It depends on liquidity © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 56

59. Bottoms Up Analysis +/- Item Amount 1120S Line 21 PLUS Taxable Income -22,870 1120S Line 13 Add Interest Expense 26,907 1120S 20 Add Depreciation 6,911 K (various lines) PLUS or Minus Interest, Rentals etc M-1 (various lines) PLUS or Minus Disallowed meals, etc -623 Equals Cash Available to Pay Debt and distributions to owners $10,325 Bad Debts ©LindaKeithCPAIncMar2015|59

61. B&J Floors: Borrower Ben 67% Jan 25% 100% Odds N Ends Medical Dan: 90% Valley Vineyards Dan: 10% Donut Shop Zac 8% 1040 1065 1065 K-1 1120S K-1 1040 1120S 1040 1120S 1120S K-1 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 61

62. Bottoms Up Analysis +/- Item Amount 1120S Line 21 PLUS Taxable Income -22,870 1120S Line 13 Add Interest Expense 26,907 1120S 20 Add Depreciation 6,911 K (various lines) PLUS or Minus Interest, Rentals etc M-1 (various lines) PLUS or Minus Disallowed meals, etc -623 Equals Cash Available to Pay Debt and distributions to owners $10,325 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 62

63. Debt List Amount B&J Floors Debt Payments $26,000 . . Total Debt Service Personal Amount Wages (including Scorp) $100,000 Capital Gains -0- Schedule E Gtd Pmnts -0- CF other than School Tools $100,000 Ben Personal Debt payments 26,604 52,604 Global Amount B&J Floors $10,325 Ben 100,000 Available from income 110,325 Less Family Living Less Income Taxes Available for Debt Combined Debt Global Margin Global DCR -40,000 -26,000 $44,325 52,604 -8,279 .84 Bottoms Up Analysis Item Amount Cash Available to Pay Debt and distributions to owners $10,325 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 63

64. The company paid out $20,892 in distributions The company paid Ben $13,914 in distributions If you are not requiring Jan or Zac to guarantee you need to subtract the extra $6,978 from company cashflow somewhere! I would do it in ‘other expense’ on my worksheet. © Linda Keith CPA Inc Mar 2015 | 64

65. Jan and Dan Borrower Jan: 25% School Tools Jan: 100% Odds N Ends Medical Dan: 90% Valley Vineyards Dan: 10% Donut Shop 1040 1065 1065 K-1 1120S K-1 1120S 1120S 1120S K-1 1120S K-1 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 65

66. Bottoms Up Analysis +/- Item Amount 1120S Line 21 PLUS Taxable Income -22,870 1120S Line 13 Add Interest Expense 26,907 1120S 20 Add Depreciation 6,911 K (various lines) PLUS or Minus Interest, Rentals etc M-1 (various lines) PLUS or Minus Disallowed meals, etc -623 Equals Cash Available to Pay Debt and distributions to owners $10,325 © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/Sageworks | 66

67. Bottoms Up Analysis Item Amount Cash Available to Pay Debt and distributions to owners $10,325 Global Amount B&J Floors X 25% $2,581 Odds N Ends X 100% Jan Available from income Less Family Living Less Income Taxes Available for Debt Combined Debt Global Margin Global DCR -36,000 -26,000 $115,490 47,500 67,990 2.43 Personal Amount Wages (including Scorp) $80,000 Alimony 30,000 Other -0- CF other than Pass-Throughs $110,000 Debt List Amount B&J Floors Debt Payments X 25% $6,500 Odds N Ends Jan Personal Total Debt Service 47,500 14,400 26,600 64,909 110,000 177,490 Odds N Ends 64,909 -14,400 $50,509 Debt to Income Ratio 47,500/177,450 = 27% © Linda Keith CPA Inc Mar 2015 | 67

75. $38,594 $24,999 Actual Additional Cashflow to owner 50,509 Available Personal Cashflow to owner Paid taxes on her share of taxable income. Guidelines based on: • Pattern • % Ownership Lenders consider: • Guidelines • Common Sense • Judgment © Linda Keith CPA Inc Mar 2015 | 75

76. © 2013 Fiserv, Inc. or its affiliates. Steps for multiple pass-through entities: 1. Diagram the relationships 1. Who is your borrower 2. Who must guarantee 3. Which returns do you need when the owner/guarantor owns an unrelated pass-through business 2. Obtain all required returns 3. Decide for each pass-through entity other than the borrower which to use: 1. Actual cashflow from the K-1 2. Cashflow available to the owner calculated from the full return times the ownership % 4. When calculating 1040 cashflow, use K-1 cashflow or entity share of cashflow instead of any K-1 pass- through items (Schedule E Page Two, Schedule B, Schedule D, etc.) © Linda Keith CPA Inc Mar 2015 | 76

77. © 2013 Fiserv, Inc. or its affiliates. Done but not done! Managers: • Modify and communicate guidelines to give clear but flexible guidance. • Check that your worksheet or software counts, but does not double-count, pass-through entity cashflow in your global calculations. • Provide the recording of this webinar and other resources to your team. • Work to help your lenders and analysts move beyond formulaic number-crunching to insights and understanding © Linda Keith CPA Inc Mar 2015 | 77

78. © 2013 Fiserv, Inc. or its affiliates. Lenders and Analysts 1. Understand your guidelines 2. Review the webinar or other resources 3. Request the 20-Video Series and other resources Done but not done! © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 78

79. Poll Question 10 Additional Opportunities with Sageworks & Linda Keith CPA © Linda Keith CPA Inc Mar 2015| Resources at www.lindakeithcpa.com/sageworks.htm | 79

80. Contact Information & Resources Linda Keith CPA Info@LindaKeithCPA.com 360.455.1569 Websites + www.LindaKeithCPA.com + Resources, blog, articles, training + www.LendersOnlineTraining.com + Self-Study eLearning + www.TaxReturnAnalysis.com + Four-week Virtual Training + www.TheLendersAcademy.com + Become a BETA Partner Resources + 20 Video Series on Pass-Through Entities + Recordings of and resources from this and previous Sageworks Webinars + Global Tax Return Analysis Quick Reference Guide + Red Flags and Green Lights in Tax Returns: Extended Handouts + Sign-up for ‘Lenders Q&A’ email with answers to real questions each month © Linda Keith CPA Inc Mar 2015| Resources at www.LindaKeithCPA.com/sageworks | 80

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