Guarantor Analysis, Global Cash Flow, and the Second Way Out (#3 in series)
Q: In calculating Mr. Schumacher’s personal cash flow you deduct taxes paid for FICA ($3,720); Medicare ($870); and City/SDI ($232). Why aren’t social security taxes withheld also deducted? Also, if Mr. Schumacher hypothetically were to provide his W-2 and it showed a deduction for amounts contributed to a 401-K or similar qualified retirement plan should that amount also be deducted from his personal cash flow since it is not cash that is available to him? Or does it not apply because it is a pre-tax contribution? Suppose it is a Roth contribution, does that make any difference?
A: FICA usually refers to both social security and Medicare taxes. Both are generally included in the term "FICA". In this instance, FICA really refers to social security taxes. It's mis-labled, in effect, in Statement 1.
If we had information about a contribution to a 401k, we should use it since it reduces the taxpayer's cash available to service debt. Cash revenue would be decreased by the amount of the contribution. Pre-tax isn't relevant because any tax impact would be picked up in computing cash taxes paid for the year. The same considerations apply to a Roth IRA.
Q: In order to find the amount of taxes paid for FICA, Medicare, and City/SDI you need Form 1040 Statement 1. In other words, in the case of Schumacher’s 2014 personal tax return the taxes he paid for FICA, Medicare, and City/SDI would not appear/are not included on page 2 of the Form 1040. Only the federal income taxes he paid are shown on Page 2. Correct?
A: FICA taxes (including Medicare) are not captured on the 1040. Very likely they will not be included in any Statement, which means that an analyst will need to estimate them, using the self-employment tax rates and thresh hold amounts for the year in question. We set up such a computation in Session 4 in the Tax College.
Q: A recent commercial loan request will be personally guaranteed by the business owner. In calculating his personal cash flow for 2018 (with respect to federal cash taxes paid) I followed the example provided for Mr. Schumacher in Exercise #3:
| Prior Year (2017) federal income tax refund: | $411,572 |
| 2018 Federal income tax withheld from W-2: | 353,000 |
| 2018 Estimated federal income tax payments: | $75,000 |
| = Total federal cash taxes paid in 2018: | $16,428 |
A: Correct, but check the 2017 return to see if there is any refund amount desginated to be applied to the 2018 federal income tax obligation. If so, use only the amount not applied as cash flow to him in 2018. For example, if he specified $200,000 of the 2017 refund to be applied to 2018 federal income taxes, then we can assume the IRS wrote him a check for $211,572 which he received and cashed in 2018.
Q: If the guarantor had applied the full amount of the 2017 tax refund to his 2018 estimated tax would I remove the refund from my numbers above or would the net effect be the same? In addition, if our guarantor receives any state income tax refunds in 2018 can I include them when calculating his total personal revenue for that year?
A: Yes, remove the full amount if he applied it all to his 2018 federal income taxes. If the taxpayer receives any state income tax refunds, use them to reduce the total of Cash Taxes Paid.
Q: On Mr. Schumacher’s 2014 1040 Schedule A (Itemized Deductions) he reports on line 14 investment interest of $9,728. Is there ever a scenario whereby this investment interest should be added back when calculating Mr. Schumacher’s annual revenue?
A: The $9,728 represents interest expense he paid on his margin account and it is included as a cash outflow in the Personal Debt Service section on the Schumacher personal cash flow statement.
Q: You mentioned to me that a Subchapter S, Partnership, or LLC will never show the Section 179 expense deduction deduction on its tax return. However, in reviewing Mr. Schumacher’s 2014 1040 Schedule E (Part II) he is reporting for Clovis Supply, LTD and Modesto Services, Inc. Section 179 expense deductions of $27,844 and $86,100 respectively. These amounts are also included on the K-1 (Form 1120S) for both Clovis Supply and Modesto Services. I’m confused? Why is this? Is there ever a scenario whereby the Section 179 expense appearing on Mr. Schumacher’s Form 1040 should be added back when calculating his personal cash flow or added back when calculating the business cash flow of Clovis Supply or Modesto Services?
A: The reference to the Section 179 Deduction never appearing on the tax returns was to the business income tax returns for a Sub S, partnership, and LLC. That is, the Section 179 Deduction never appears as an expense in computing ordinary business income for those three types of business organizations. Therefore, it is not - and cannot - be added back in computing traditional cash flow or EBITDA based only on the business income tax returns. Further, it never appears - is disallowed by GAAP - as an expense on an accrual income statement.
Re the personal cash flow statement, the Section 179 Deduction is used only to reduce ordinary business income reported by an owner of partner of an S Corp, partnership,or LLC on his or her Schedule E. The resulting number is non-cash to the taxpayer and is not used in computing a personal cash flow statement.
The Section 179 Deduction is never used in computing cash flow for a Sub S, partnership, or LLC. Nor is it ever used in computing the personal cash flow statement for owners of a Sub S, partnership, or LLC.