For the last installment we are going to look at the 1120S and 1120 corporation returns inside the lens of the cash flow analysis form.  These two business entities really differ from sole proprietors and partnerships because they have the most legal separation between the shareholders and the business itself in terms of liability for debts and legal matters.  For instance if you own stock in General Motors you would have no concerns legally over the current lawsuits battles because they can’t sue you personally for owning one hundred shares of stock in GM.

A few of the differences between 1120S and 1120 you should know when reviewing a borrowers return:

  • 1120S can issue a borrower a K-1 and W-2 where a 1120 corporation only issues W-2’s (and dividends)
  • 1120S pays no corporate taxes while 1120’s pay corporate taxes (hence the K-1 difference)
  • Per FNMA for property single family property ownership only properties owned by an 1120 are not counted in the maximum of 10 financed properties (as long as the mortgage is not in the owner’s name)
    (FNMA AllRegs B2-2-03)
  • Per FNMA  you must NOT use any “additional” income from the business return unless the borrower  is 100% owner of the 1120 corporation.  Note for married couples who have split ownership it is acceptable if they are both on the application and their joint ownership equals 100%.  So bottom line, don’t go digging into a corporate return for deprecation if your borrower is only 75% owner of an 1120.
    (FNMA AllRegs B3-3.2.2-03)

Now onto to the key boxes in the 1120S and 1120 needed for the cash flow analysis!  If you have read the other three part of this blog, the explanations will look similar.  If you see unfamiliar terms I’d encourage you to read parts 1 through 3.

1120S Returns

1120S Line 4 Net Gain form 4797  – Real Money Earned (+) or Spent (-)

1120S Line 5 Other Income – Real Money Earned (+) or Spent (-)

The reason you have to adjust for these two lines is that they are reserved for income not earned in the normal course of business.  Example: I own a car dealership so my 1120S form is all about my car dealership.  However lines 4 & 5 are income from other sources outside of my dealership.  Therefore, if I want to leave it in my cash flow I have to separately document the income.  I need to ask: “has the borrower received it for two years”, and “is it likely it will continue for three years”.

So if the answer is YES and you can document it all… do nothing to the numbers.  If the answer is NO (either due to lack of documentation or not meeting history/future requirements) you must SUBTRACT this income from the borrower’s cash flow.  On the other hand if the income in these lines is NEGATIVE or a loss you can add back in that loss IF you can document it is NOT likely to continue in the future (that is trickier!!).

1120S Line 14 Depreciation – Noncash Expense
Refers to prorating a tangible asset’s cost over that asset’s life.  For example, a commercial printer is used for a number of years before it becomes worn out and must be replaced.  The cost of the equipment is spread out over the predicted life of the equipment, with a portion of the cost being expensed each accounting year, it can be added back based on the ownership percentage to the borrower.

1120S Line 15 Depletion – Noncash Expense
Refers to the allocation of the cost of natural resources over time.  For example, an oil well has a finite life before all of the oil is pumped out.  Therefore, the oil well’s setup costs are spread out over the predicted life of the oil well.  Since FNMA/FHLMC understands that a business did not write this check to anyone, it can be added back based on the ownership percentage to the borrower.

1120S Schedule L line 17D – Real Money Spent
This line tends to mess up a lot of loans!  If there is a number listed in line 17D you must subtract the percentage of debt from the borrower’s income.  What this represents is a short term debt or mortgage.  Therefore, if the Schedule L shows there is short term debt or mortgage due this tax year…well you HAVE to pay it!  For example if a company only has $50,000 in assets and owes a $100,000 mortgage within one year they are broke (or will go further in debt)!  Fear not, there are a few ways you can mitigate this line.

Method A
Document this is a roll over debt or mortgage, some of these debts and mortgages are paid off and renewed on a yearly basis.  If you can document the debt is not actually due you don’t have to subtract it from the borrowers income.
Method B
Review the Schedule L and if the company has enough liquid assets to cover the debt, you do not need to subtract this from the borrower’s income.

1120S Schedule M1- Line 3B – Real Money Spent
The IRS allows you to write off 50% of the full amount of receipts turned in for this category.  For example if you turn in $1,000 of receipts on line 4B it will show and “expense” of $500.  Because FNMA and FHLMC know the IRS only allows 50% you are required to subtract the “other” 50% based on percentage of ownership from the borrower’s income.

 

1120 Returns

1120S Line 4 Net Gain form 4797  – Real Money Earned (+) or Spent (-)

1120S Line 5 Other Income – Real Money Earned (+) or Spent (-)

Lines 4 and 5 are the same as 1120, so see the prior description for how to handle these lines.

1120 Line 8 Capital Gain Income  – Real Money Earned (+) or Spent (-)

1120 Line 9 Net Gain Form 4797  – Real Money Earned (+) or Spent (-)

1120 Line 10 Other Income – Real Money Earned (+) or Spent (-)

1120 Line 20 Depreciation – Noncash Expense
Refers to prorating a tangible asset’s cost over that asset’s life.  For example, a bulldozer is used for a number of years before it becomes worn out and must be replaced.  The cost of the equipment is spread out over the predicted life of the equipment, with a portion of the cost being expensed each accounting year, it can be added back based on the ownership percentage to the borrower.

1120 Line 21 Depletion – Noncash Expense
Refers to the allocation of the cost of natural resources over time.  For example, an oil well has a finite life before all of the oil is pumped out.  Therefore, the oil well’s setup costs are spread out over the predicted life of the oil well.  Since FNMA/FHLMC understands that a business did not write this check to anyone, it can be added back based on the ownership percentage to the borrower.

1120 Line 25 Domestic Production Activities – Non Cash Expense
A deduction against income derived from domestic manufacturing activities.  The domestic production activities deduction is designed to encourage domestic production and production-related activities. It is also known as the “manufacturer’s deduction.  Bottom line it’s a government incentive to reduce taxes so it is NOT real cash spent so can be added back on.

1120 Line 29A Net Operating Loss – Non Cash Expense
This is a carryover loss from previous years, therefore not a real cash outlay.  So it can be added back into the borrowers income.

1120 Line 29B Special Deduction – Non Cash Expense
The short version of this line is this is an IRS deduction for a depreciation allowance to recover part of the cost of qualified property.  It is not a cash outlay so it can be added back into the bottom line of the company.

1120 Line 31 Total Tax – Real Spent Money
As stated above only the 1120 pays corporate taxes so this is real money spent and therefore subtracted from gross profit on line 30.

1120 Schedule L line 17D – Real Money Spent
This line tends to mess up a lot of loans!  If there is a number listed in line 17D you must subtract the percentage of debt from the borrower’s income.  What this represents is a short term debt or mortgage.  Therefore, if the Schedule L shows there is short term debt or mortgage due this tax year…well you HAVE to pay it!  For example if a company only has $50,000 in assets and owes a $100,000 mortgage within one year they are broke (or will go further in debt)!  Fear not, there are a few ways you can mitigate this line.

Method A
Document this is a roll over debt or mortgage, some of these debts and mortgages are paid off and renewed on a yearly basis.  If you can document the debt is not actually due you don’t have to subtract it from the borrowers income.
Method B
Review the Schedule L and if the company has enough liquid assets to cover the debt, you do not need to subtract this from the borrower’s income.

1120 Schedule M1- Line 5c – Real Money
The IRS allows you to write off 50% of the full amount of receipts turned in for this category.  For example if you turn in $1,000 of receipts on line 4B it will show and “expense” of $500.  Because FNMA and FHLMC know the IRS only allows 50% you are required to subtract the “other” 50% based on percentage of ownership from the borrower’s income.

These next three lines can be a real deal killer if you are NOT careful!

1120 Sch M2 – Line 5A Dividend Cash

1120 Sch M2 – Line 5B Dividend Stock

1120 Sch M2 – Line 5C Dividend Property


As stated in the beginning of this article a 1120 business does NOT give out K-1’s due to the tax structure.  But if the company makes a profit the shareholder(s) can take profit in the form of a dividend.  If you are looking at a borrower’s return and using the dividend on line 9A or 9b from this same company and DO NOT subtract the dividend income from this business you are double dipping the income since the dividends are the profit.  If you count the profit in the business, then count the transfer of the profit to the borrower you have double dipped the income.

We hope these explanations for the cash flow analysis boxes to properly determine income for self-employed borrowers has been helpful!  We know there is a lot of information to memorize for these borrowers and that is why we built UberWriter!  This free online income analysis tool will help you get the borrowers income fact, accurate, and documented!  Check it out at www.uber-writer.com