Top Questions on Global Cash Flow and Pass-Through Entities
One of the more challenging components of tax return analysis is analyzing global cash flow with multiple pass-through entities – especially without double-counting or leaving cash flow out. Linda Keith, president of Linda Keith CPA, partnered with Abrigo to lead a webinar aimed at clarifying the confusion on pass-through entities.
During the webinar, Keith discussed how to strengthen guidelines and improve consistency, how to pull the right cash flow from a pass-through entity into global calculations and how to avoid double-counting cash flow. More than 270 lenders joined the webinar, and 57 questions were asked. Keith created a 32-video series of brief responses to those questions, and four of the top questions and their answers are included below.
How many years of tax returns should be used?
Keith recommends using three years instead of two. When only two are used, it is tough to get a sense of what is considered “normal.” Using three years provides additional insight. Keith also states, “If you’re new to a borrower who is not new to the bank, you often have a larger file, and I’d look at the last five years.”
What is the difference between income and cash flow?
Keith states that cash flow is the one that actually pays debt and pays the owners. She offered an example: “If you’re paid monthly on the first day of each month, you’ve earned your wages at the end of the month. If someone asked you for some money the last day of the month, you might ask they wait until you receive your paycheck the next day. It is the cash flow that pays.”
What amount do you recommend for family living expenses?
Keith recommends that you have a guideline with some flexibility. She comments that as a lender, “you know some of your borrowers are more frugal than others. Frequently, it is X dollars based on geographic location plus some amount per dependent. Then, lenders will look at Schedule A or the various debts to get a feel for if the individual has really expensive hobbies that could increase the living expenses.” For agriculture lending, it is often important to consider if the individual(s) live on or off the farm since those living on the farm often have few living expenses as they’re intermingled with the farm expenses. Overall, Keith states that there isn’t a set rule of thumb, but she’s seen $30,000 up through $60,000 used, or in other cases, a percentage of income.
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What happens when you don’t receive the K-1s?
It depends on your guidelines and instructions, according to Keith. Without the K-1, you risk that their “actual cash flow is significantly different than what you’re seeing on the Schedule E page 2 – that page is just their shared, taxable income.” She adds, “What if there is no depreciation but there’s a ton of debt? That number is not even close to what the company could afford to pay.” Keith points out there is a significant difference between three numbers: the taxable income on the back of Schedule E, the actual cash flow on the K-1 and their share of the available cash flow from the full entity return.
For more on using tax returns for global cash flow with multiple pass-through entities, you can access Linda Keith’s video series.