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Session #4: Personal Income Tax Returns and Cash Flow

Q: Where else can a loan repayment to an owner be found on Schedule K-1?

A: To clarify, the loan repayment to an owner can only be found only on Schedule K-1 (Form 1120S). This information is not captured on Schedule K-1 (Form 1065).

In addition to being found on the Schedule K-1 (Form 1120S), Schedule L for both Form 1120S and Form 1065 reports loans from owners in the business income tax returns. And, keep in mind, that the accrual financial statements will also report loans from owners/partners.

Q: How do we know that the $5,100 tax-exempt interest from line 8b is cash flow or isn't cash flow?

A: Tax exempt interest income usually represents interest income from municipal bonds that are largely or completely exempt from income tax. So, you can check the taxpayer's personal financial statement to see if he or she lists municipal bonds on the personal balance sheet. The amount would usually be reported in a Statement to Form 1040 (see Statement 2 for Douglas McPherson) or, possibly, but infrequently, noted on Schedule B. Only if an interest income amount is designated as "From Schedule K-1" of Schedule B is it a non-cash amount for the taxpayer.

Unless there is a compelling reason to suspect that tax-exempt interest income is not cash to the taxpayer, always consider it cash to the taxpayer.

Q: With respect to the interest income on Schedule B of $20,085, is that interest expensed by the company (Sandover Contractors)?

A: Yes, interest income paid by an entity on a loan to the business is a tax-deductible business expense. That interest income becomes taxable income for the recipient of those interest payments. In this case, Sandover Contractors pays (and deducts) the interest expense, and Douglas McPherson reports the corresponding interest income paid to him by Sandover Contractors in Part I on his Schedule B with all other taxable interest income.

Note that principle repayments are not tax-deductible expenses to the business nor are they taxable to the lender (in this case McPherson.).