ANALYZING TAX RETURNS
STEPHEN FURR, CPA
ADVANTAGES OF
TAX RETURNS
• OFTEN THE MOST OBJECTIVE DATA
AVAILABLE
– ANNUAL REQUIREMENT AT FEDERAL &
STATE
– OFTEN PROFESSIONALLY PREPARED BY
CERTIFIED PROFESSIONALS
– DATA IS ALREADY SUMMARIZED AND
OFTEN RECONCILED IN PREPARATION
– TRENDS OVER TIME
DISADVANTAGES OF TAX
RETURNS
•
•
•
•
•
MULTIPLE FORMS USED
MULTI-PAGES ON EACH FORM
COMPLICATED COMPUTATIONS
SCHEDULES AND WORKSHEETS
GAINS, LOSSES, DEPRECIATION,
DISTRIBUTIONS, DRAWS, EQUITY, K-1,
SCHEDULE A, B, C
• TIME CONSUMING TO ANALYZE
MULTIPLE YEARS
MOST COMMON
FED BUSINESS RETURNS
• SOLE PROPRIETORS
– SCHEDULE C FORM 1040
• SINGLE MEMBER, LLC
– SCHEDULE C FORM 1040
• PARTNERSHIPS & MULTI-MEMBER LLC
– FORM 1065
• SUB-CHAPTER S CORPORATIONS
– FORM 1120S
1065 & 1120 S
• INCOME PASSES THROUGH THE
RETURN TO THE FORM 1040
PERSONAL RETURN
• PASS THROUGH MADE VIA SCHEDULE
K-1
• BOOK AND TAX INCOME NOT ALWAYS
THE SAME AND SHOULD (NOT ALWAYS
REQUIRED) BE RECONCILED
1065 & 1120S
• ITEMS REQUIRING RECONCILIATION
– INTEREST, DIVIDEND, AND OTHER
INVESTMENT INCOME NOT COMPUTED IN
TAX INCOME (Pass through).
– NOT ALL EXPENSES ARE DEDUCTIBLE
• MEALS AND ENTERTAINMENT (50%)
• CHARITABLE CONTRIBUTIONS (Pass through)
• SECTION 179 DEPRECIATION (Pass through)
1065 & 1120S
• OTHER ISSUES
– DRAWS AND DISTRIBUTIONS- NOT
EXPENSES BUT EQUITY TRANSACTIONS
AFFECTING CASH FLOW
– LOANS TO/FROM SHAREHOLDERSNEITHER INCOME/EXPENSE BUT
ASSET/LIABILITY TRANSACTIONS
AFFECTING CASH FLOW
SITUATION
• MULTIPLE YEARS OF TAX FORMS TO
EXAMINE
• DIFFERENT TYPES OF FORMS
• ALLEGED CHANGE IN BUSINESS
STRUCTURE AND OWNERSHIP
THE DATA
2008
Form 1065
2009
Begin
End
Form 1065
2009
Begin
End
Form 1120S
2010
Begin
End
Form 1120S
Begin
End
Assets
Cash
A/R Net
Inventory
Fixed Assets
(AccumDepr)
Other assets
Total
Assets
Liabilities
A/P
Cur Liabilities
Notes Payable
Capital #1 (90%)
Capital #2 (10%)
Total
Liabilities
and Capital
5,816
107,870
22,757
(18,190)
14,861 Cash
A/R Net
98,558 Inventory
25,174 Fixed Assets
(21,826) (AccumDepr)
Other assets
118,253
116,767
16,026
3,002
23,652
64,937
10,636
26,664
944
37,894
43,059
8,206
118,253
116,767
14,861
98,558
25,174
(21,826)
116,767
A/P
Cur Liabilities
Notes Payable
Capital #1 (90%)
Capital #2 (10%)
Cash
A/R Net
Inventory
Fixed Assets
(AccumDepr)
Other assets
26,664
944
37,894
43,059
8,206
14,741 Cash
A/R Net
86,634 Inventory
2,651 Fixed Assets
(379) (AccumDepr)
Other assets
0
103,647
A/P
Cur Liabilities
Shareholder Loans
Retained Earnings
0 Capital Stock
20,132
14,378
40,942
28,195
116,767
A/P
Cur Liabilities
Shareholder Loans
Retained Earnings
Capital Stock
103,647
14,741
86,634
2,651
(379)
100,492
18,646
(3,218)
103,647
115,920
20,132
14,378
40,942
28,195
27,270
30,351
2,262
56,037
103,647
115,920
BALANCE
SHEET
Schedule L
Income
Sales
Beg Inv
Purchases
End Inv
COGS
Gross Profit
107,870
213,616
(98,558)
471,586 Sales
Beg Inv
Purchases
End Inv
(222,928) COGS
248,658 Gross Profit
98,558
99,255 Sales
Beg Inv
Purchases
End Inv
(98,558) COGS
697 Gross Profit
0
320,072
(86,634)
520,120 Sales
Beg Inv
Purchases
End Inv
(233,438) COGS
286,682 Gross Profit
520,035
86,634
231,971
(100,492)
INCOME
(218,113)
301,922
Expenses
Salaries
Rent
Interest
Taxes
Depreciation
Amortization
Other Deductions
62,803
26,400
2,463
6,137
4,352
1,178
84,032
Total
Expenses
Net Income
Salaries
Rent
Interest
Taxes
Depreciation
Amortization
Other Deductions
Salaries
Rent
Interest
Taxes
Depreciation
Advertising
Other Deductions
697
187,365
61,293
697
0
100,176
29,400
1,179
10,105
379
50,173
67,075
Salaries
Rent
Interest
Taxes
Depreciation
Advertising
Other Deductions
285,487
28,195
99,362
35,200
839
10,121
2,934
60,598
64,259
273,313
28,609
Capital/
Retained
Earnings
Open
Income
Distributions
End
Partner 1
Partner 2
64,937
10,636
55,163
6,130
(77,041)
43,059
(8,560)
8,206
Partner 1
43,059
0
(51,265)
(8,206)
Partner 2
8,206
0
8,206
Shareholder 1
0
28,195
Shareholder 1
28,915
28,609
28,195
56,037
SCHEDULE
K-1
Income Expense Data
as Percentage of Sales
Sales
Beg Inv
Purchases
End Inv
COGS
Gross Profit
2008
1065
1.0000
2009
2009
2009
2010
1065 1120S
Combined 1120S
1.0000
1.0000
1.0000
1.0000
(0.4727)
0.5273
(0.9930)
0.0070
(0.4488)
0.5512
(0.5360)
0.4640
(0.4194)
0.5806
0.3973
0.1300
0.0070
0.0000
0.5489
0.0542
0.4621
0.0455
0.5256
0.0550
Salaries
Rent
Interest
Taxes
Depreciation
Advertising
Other Deductions
Total Expenses
Net Income
• Significant trends
– Gross Profit up over 5%
– Expenses up almost
13%
– Net Income down 8%
Income & Expense Net Change
•
•
•
•
•
Sales Increase 10%
COGS Decrease 2%
Gross Profit Increase 21%
Expenses Increase 45%
Net Income Decrease 54%
Sales
Beg Inv
Purchases
End Inv
COGS
Gross Profit
Change
%
2008-2010 Change
48,449
1.1027
4,815
53,264
0.9784
1.2142
85,948
(32,684)
1.4587
0.4668
Salaries
Rent
Interest
Taxes
Depreciation
Advertising
Other Deductions
Total Expenses
Net Income
• Critical to Analyzing Cash
Flow
• From Schedule L of Form
1065 and 1120S
• Begin by Computing
Annual Changes in Assets
Liabilities and Equity
• The Accounting Equation
– Assets = Liabilities +
Equity
• Increases in Assets are
deemed reductions in
Cash
• Increases in Liabilities are
deemed increases in Cash
• Changes in Equity should
reflect Net Income
• Remember NonDeductible Expenses
Balance Sheet Analysis
Cash
A/R Net
Inventory
Fixed Assets
(AccumDepr)
Other assets
A/P
Cur Liabilities
Notes Payable
Capital #1 (90%)
Capital #2 (10%)
2008
1065
9,045
0
(9,312)
2,417
(3,636)
0
2009
2009
2009
2010
1065 1120S
Combined 1120S
(14,861) 14,741
(120) (14,741)
0
0
0
0
(98,558) 86,634 (11,924) 13,858
(25,174)
2,651 (22,523) 15,995
21,826
(379) 21,447
(2,839)
0
0
0
0
(1,486) (116,767) 103,647
0
0
0
10,638 (26,664) 20,132
(2,058)
(944) 14,378
14,242 (37,894) 40,942
(21,878) (43,059) 28,195
(2,430) (8,206)
0
(13,120)
0
(6,532)
13,434
3,048
(14,864)
(8,206)
12,273
0
7,138
15,973
(38,680)
27,842
0
Net Change
(5,816)
0
(7,378)
(4,111)
14,972
0
(2,333)
0
11,244
27,349
(21,390)
(8,900)
(10,636)
STATEMENT OF CASH
FLOWS
• Cash Flow Does not add up
• Problem appears to be with 2009 Change in Structure
2008
Form 1065
Cash Flows from Operating Activities
Net Income
Adjustments to Net Income
Depreciation
Amortization
Loss on Sale of Equipment
Gain on Sale of equipment
Change in Inventory
Change in Accounts Payable
Change in Current Liabilities
Non-Deductible Expenses
Net Cash from Operations
Cash Flows from Investing Activities
Purchase of Equipment
Sale of Equipment
Net Cash From Investing
Cash Flows From Financing Activities
Change in Loans and Notes Payable
Draws/Distributions
Net Cash From Financing Activities
Net Increase (Decrease) in Cash
Balance Sheet Cash at Beginning
Calaculated Cash at End
Balance Sheet Cash
Over/(Short)
Cumulative Difference
2009
Form 1065
2009
Form 1120S
2009
Combined
2010
Form 1120S
61,293
0
28,195
28,195
28,609
4,532
1,178
697
379
1,076
2,934
9,312
10,638
(2,058)
98,558
(26,664)
(944)
(86,634)
20,132
14,378
11,924
(6,532)
13,434
23,602
71,647
(51,745)
19,902
(13,858)
7,138
15,973
(767)
11,420
(2,417)
25,174
(2,651)
22,523
(15,995)
(2,417)
25,174
(2,651)
22,523
(15,995)
14,242
(85,601)
(71,359)
11,119
5,816
16,935
14,861
(2,074)
(24,692)
(37,894)
(51,265)
(89,159)
7,662
14,861
22,523
0
(22,523)
40,942
3,048
(51,265)
(48,217)
22,403
14,861
37,264
14,741
(22,523)
(38,680)
40,942
14,741
0
14,741
14,741
0
(38,680)
(14,646)
14,741
95
0
(95)
Further Things to Research
• 2009 Dissolution of
Partnership
– Check for Affidavit of
Dissolution with Sec State
• Creation of 1120S
Corporation
– Check with Sec State for
Charter
– Ask for copy of IRS Form
2253- Application
– Ask for Copy of IRS Letter
approving S Corp Status
• Check for verification of
Advertising Expense- no
discernible positive
impact on sales
• Check for Agreement by
Partner 2 to Partner 1
receiving distribution on
dissolution
• Verify salaries and wages
expense