Reading Income Tax ReturnsPresented by Underwriting Team

Outline • Introductions• Sole Proprietorship• Partnership• Corporation• S Corporation• Limited Liability Company (LLC)

• Key Financial Ratios• Tax Return Interpretation• Individual Tax Return (Form 1040)• Proprietorship (Schedule C)• Partnership and LLC (Form 1065)• Corporation (Form 1120)• S Corporation (Form 1120S)

First things first…

• CHECK:Check the Name

IndividualsBusiness

SSNTax Period coveredComplete return ( will cover more later)And very important…..

IT MUST BE SIGNED

“Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge”

Relationship between Individual Tax Returns and Business Tax Returns

Entity Sole Proprietorship

C corporation S corporation Limited & General partnership

Limited Liability Company (LLC)

Tax Form IRS form 1040-Schedule C or EZ

IRS Form 1120 IRS Form 1120S IRS form 1065 • One member: Form 1040 Schedule C

• More than 1 member: Form 1065

Owners No separate forms •1099-contract work•W2-salaries (Schedule E)•Schedule K-

•Schedule K1•1099-contract work•W2-salaries

•Schedule K1•1099-contract work•W2-salaries

Schedule K11099-contract workW2-salaries

Sole Proprietorship

• Definition by the IRS: • an entity that is an incorporated business owned by a single

taxpayer

• Tax implications• Use schedule C for reporting income and expense• Subject to self-employment tax (FICA) taxes on employee income• Subject to both employer and employee portion of FICA for the

sole proprietor

• Advantages:• Easy tax returns (only need to fill out schedule C compared to

other forms of business)

Limited and General Partnership

• IRS Definition: a relationship between two or more persons who join to carry a business. Each person contributes skills, labor or capital, and expects to share profits and losses of the business

• Tax Implications: • Must file a separate annual return to report income, losses,

deductions and gains, etc. (Form 1065)• A partnership does not pay income taxes; profits or losses pass

through to individual partners on his or her individual tax return• Partners are not employees, therefore must pay both income tax

and self-employment tax

• Advantages: partners of limited partnership separate personal liabilities from liabilities of the partnership entity

Corporation

• IRS Definition: prospective shareholders exchange money or property for corporation’s capital stock. C-Corporation is recognized as a separate taxpaying entity (Form 1120)• Tax Implications: • Profit of a corporation is taxed when earned, and taxed again

when passed through to individual shareholders– “double taxation”

• Loss cannot be deducted by individual shareholders; dividends are not tax-deductible for corporations

• Need to pay income tax and employment taxes including: • Social security and Medicare taxes• Income withholding• Federal unemployment tax (FUTA)

S Corporation• IRS Definition: S Corporation are corporations that elect to pass

corporate income and losses to shareholders for federal tax purposes. To qualify, the corporation must meet the following requirements:• Domestic corporation• Shareholders can only be individual, certain trust and estates• Have one class of stock• Have no more than 100 shareholders

• Tax Implications:• Shareholders report income and losses on their personal tax returns at the

individual income tax rate (Form 1120S)• Avoid double taxation experienced by corporations

Limited Liability Company (LLC)• IRS Definition:

• A LLC is allowed by state statute. Depending on elections made by members of the LLC, the IRS will treat a LLC as either a corporation, partnership, or a disregarded entity (income and losses passed through to individual members)

• Members of the LLC enjoy “limited liabilities’– separate personal liabilities from liabilities of the LLC

Texas Louisiana Alabama

Formation Requirements

One member is allowed to form a LLC (at least one member); member can be individual, partnership, corporation or any other legal or commercial entity

Two or more members; previous entity can be corporation or partnership before electing to be LLC

One or more members or managers

State Income Tax Classification

State taxes as LLC as corporations; no state personal income tax

Follow Federal classification with respect to corporate income tax but not franchise tax

Follows Federal Income Tax Classification

Key Financial Ratios• Profit margin: • Profit Margin=

• Applies only to Form 1120, 1120S or Form 1065• Current Ratio: Measures the ability to pay short-term obligations

• Current ratio= • Debt service Coverage: measures the ability to produce enough cash to cover its debt

payments (>=1)• DSCR= (total debt service includes annual mortgage payments such as principal, interest, property taxes and

payments to all other loans)

• Accounts Receivable Turnover: measures the efficiency of a company to use its assets; a high ratio may imply that a company operates on a cash basis, or its extension of credit and collections of receivables are efficient• A/R Turnover=

• Accounts Payable Turnover: Measures the rate at which a company pays off its suppliers• A/P Turnover=

Individual Tax Return

IRS Form 1040 most common for individuals that owned a business.

The first page shows a summary of the different sources of income-Including:

a) Salaries

b) Dividends from investments or from C corporation

c) Business profits (Schedule C)

d) Schedule D- Capital gains from Investments

e) IRA Distributions

f) Schedule E- Rental real estate, royalties, distribution of profits/losses from partnerships, S corporations, trusts, and other businesses organized different than sole-proprietorship

g) Social Security Benefits

Need complete tax return- check first page for verification of schedules needed.

Schedule C– Sole Proprietorship Business Income and Expenses

Sole Proprietorship: Example

Part I: Income Section

Line 1: Gross Revenue: $60,288

Line 4: Cost of Goods Sold

Line 5: Gross Profit=Gross Revenue-COGS: $60,288

Part II: Expense Section

Line 28: Total Expenses before “expenses for business use of home” (line 30): $42,439

Line 31: Net profit: $18, 501

Schedule E-Partnership (attached to individual tax return)

IRS Form 1120-C CorporationPage one: Income and Tax

Deductions Section

Line 1b: Gross Revenue $670,525

Line 2: Cost of Goods Sold $330,206

Line 3: Gross Profit $280,524

Line 18: Interest Expense

Line 34: Total estimated current year tax payment due

IRS Form 1120-C Corporation Schedule L: Balance Sheet Per Books

Line 1-6: Current Asset Accounts

Line 16-18: Current Liability Accounts

End of the Year Balance

Balance as of the Beginning of the Year

Line 1: Net Income per books

Form 1120S-S Corporation

IRS Form 1065- Partnership & LLC

QUESTIONS?