ANALYZING TAX RETURNSSTEPHEN 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 COMMONFED 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 SHAREHOLDERS- NEITHER 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 DATA2008 2009 2009 2010

Form 1065 Begin End Form 1065 Begin End Form 1120S Begin End Form 1120S Begin EndAssets

Cash 5,816 14,861 Cash 14,861 Cash 14,741 Cash 14,741A/R Net A/R Net A/R Net A/R NetInventory 107,870 98,558 Inventory 98,558 Inventory 86,634 Inventory 86,634 100,492Fixed Assets 22,757 25,174 Fixed Assets 25,174 Fixed Assets 2,651 Fixed Assets 2,651 18,646(AccumDepr) (18,190) (21,826) (AccumDepr) (21,826) (AccumDepr) (379) (AccumDepr) (379) (3,218)Other assets Other assets Other assets Other assets

Total Assets 118,253 116,767 116,767 0 103,647 103,647 115,920Liabilities

A/P 16,026 26,664 A/P 26,664 A/P 20,132 A/P 20,132 27,270Cur Liabilities 3,002 944 Cur Liabilities 944 Cur Liabilities 14,378 Cur Liabilities 14,378 30,351Notes Payable 23,652 37,894 Notes Payable 37,894 Shareholder Loans 40,942 Shareholder Loans 40,942 2,262Capital #1 (90%) 64,937 43,059 Capital #1 (90%) 43,059 Retained Earnings 28,195 Retained Earnings 28,195 56,037Capital #2 (10%) 10,636 8,206 Capital #2 (10%) 8,206 0 Capital Stock Capital Stock

Total Liabilities and Capital 118,253 116,767 116,767 103,647 103,647 115,920

Income

Sales 471,586 Sales 99,255 Sales 520,120 Sales 520,035Beg Inv 107,870 Beg Inv 98,558 Beg Inv 0 Beg Inv 86,634Purchases 213,616 Purchases Purchases 320,072 Purchases 231,971End Inv (98,558) End Inv End Inv (86,634) End Inv (100,492)COGS (222,928) COGS (98,558) COGS (233,438) COGS (218,113)Gross Profit 248,658 Gross Profit 697 Gross Profit 286,682 Gross Profit 301,922

ExpensesSalaries 62,803 Salaries Salaries 100,176 Salaries 99,362Rent 26,400 Rent Rent 29,400 Rent 35,200Interest 2,463 Interest Interest 1,179 Interest 839Taxes 6,137 Taxes Taxes 10,105 Taxes 10,121Depreciation 4,352 Depreciation 697 Depreciation 379 Depreciation 2,934Amortization 1,178 Amortization Advertising 50,173 Advertising 60,598Other Deductions 84,032 Other Deductions Other Deductions 67,075 Other Deductions 64,259

Total Expenses 187,365 697 285,487 273,313Net Income 61,293 0 28,195 28,609

Capital/ Retained Earnings

Partner 1 Partner 2 Partner 1 Partner 2 Shareholder 1 Shareholder 1Open 64,937 10,636 43,059 8,206 0 28,915Income 55,163 6,130 0 0 28,195 28,609

Distributions (77,041) (8,560) (51,265)End 43,059 8,206 (8,206) 8,206 28,195 56,037

BALANCE SHEET

Schedule L

INCOME

SCHEDULE K-1

Income Expense Data as Percentage of Sales

• Significant trends– Gross Profit up over 5%– Expenses up almost

13%– Net Income down 8%

2008 2009 2009 2009 20101065 1065 1120S Combined 1120S

Sales 1.0000 1.0000 1.0000 1.0000 1.0000Beg InvPurchasesEnd InvCOGS (0.4727) (0.9930) (0.4488) (0.5360) (0.4194)Gross Profit 0.5273 0.0070 0.5512 0.4640 0.5806

SalariesRentInterestTaxesDepreciationAdvertisingOther Deductions

Total Expenses 0.3973 0.0070 0.5489 0.4621 0.5256Net Income 0.1300 0.0000 0.0542 0.0455 0.0550

Income & Expense Net Change

• Sales Increase 10%• COGS Decrease 2%• Gross Profit Increase 21%• Expenses Increase 45%

• Net Income Decrease 54%

Change %2008-2010 Change

Sales 48,449 1.1027Beg InvPurchasesEnd InvCOGS 4,815 0.9784Gross Profit 53,264 1.2142

SalariesRentInterestTaxesDepreciationAdvertisingOther Deductions

Total Expenses 85,948 1.4587Net Income (32,684) 0.4668

Balance Sheet Analysis• 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 Non-Deductible Expenses

2008 2009 2009 2009 2010 Net Change1065 1065 1120S Combined 1120S

Cash 9,045 (14,861) 14,741 (120) (14,741) (5,816)A/R Net 0 0 0 0 0 0Inventory (9,312) (98,558) 86,634 (11,924) 13,858 (7,378)Fixed Assets 2,417 (25,174) 2,651 (22,523) 15,995 (4,111)(AccumDepr) (3,636) 21,826 (379) 21,447 (2,839) 14,972Other assets 0 0 0 0 0 0

(1,486) (116,767) 103,647 (13,120) 12,273 (2,333)0 0 0 0 0 0

A/P 10,638 (26,664) 20,132 (6,532) 7,138 11,244Cur Liabilities (2,058) (944) 14,378 13,434 15,973 27,349Notes Payable 14,242 (37,894) 40,942 3,048 (38,680) (21,390)Capital #1 (90%) (21,878) (43,059) 28,195 (14,864) 27,842 (8,900)Capital #2 (10%) (2,430) (8,206) 0 (8,206) 0 (10,636)

STATEMENT OF CASH FLOWS

• Cash Flow Does not add up• Problem appears to be with 2009 Change in Structure

2008 2009 2009 2009 2010Form 1065 Form 1065 Form 1120S Combined Form 1120S

Cash Flows from Operating ActivitiesNet Income 61,293 0 28,195 28,195 28,609

Adjustments to Net IncomeDepreciation 4,532 697 379 1,076 2,934Amortization 1,178Loss on Sale of EquipmentGain on Sale of equipmentChange in Inventory 9,312 98,558 (86,634) 11,924 (13,858)Change in Accounts Payable 10,638 (26,664) 20,132 (6,532) 7,138Change in Current Liabilities (2,058) (944) 14,378 13,434 15,973Non-Deductible Expenses (767)

Net Cash from Operations 23,602 71,647 (51,745) 19,902 11,420Cash Flows from Investing Activities

Purchase of Equipment (2,417) 25,174 (2,651) 22,523 (15,995)Sale of Equipment

Net Cash From Investing (2,417) 25,174 (2,651) 22,523 (15,995)Cash Flows From Financing Activities

Change in Loans and Notes Payable 14,242 (37,894) 40,942 3,048 (38,680)Draws/Distributions (85,601) (51,265) (51,265)

Net Cash From Financing Activities (71,359) (89,159) 40,942 (48,217) (38,680)Net Increase (Decrease) in Cash 11,119 7,662 14,741 22,403 (14,646)Balance Sheet Cash at Beginning 5,816 14,861 0 14,861 14,741Calaculated Cash at End 16,935 22,523 14,741 37,264 95Balance Sheet Cash 14,861 0 14,741 14,741 0Over/(Short) (2,074) (22,523) 0 (22,523) (95)Cumulative Difference (24,692)

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