Q: How do you determine if capital gains are cash or non-cash?
A: In general, an unrealized gain, such as an increase in stock prices, is not taxable income since it is "unrealized", i.e., has not been sold at the higher prices and transformed to an actual or "realized" capital gain. But if the capital gain has been "realized", it becomes a cash capital gain and id certainly subject to taxation. For example, the amounts reported at Line 8a on Douglas McPherson's Schedule D are all cash amounts.
However, there are many instances in which a taxable capital gain is a non-cash event for the taxpayer. The $36,456 capital gain reported at Line 9a on the Schedule K-1 (Form 1065) distributed by Greater Pacific Realty Partners and carried to Line 12 on McPherson's Schedule D is a non-cash capital gain. It was a cash capital gain for Greater Pacific Realty Partners, which McPherson must report as a taxable event on his Schedule D. It was cash to Greater Pacific but non-cash to Douglas McPherson.
In effect, each capital gain must be examined in detail to determine whether it is a cash or non-cash event. Carefully review the amounts reported on any Schedules K-1 to determine if the amounts are flow-through taxable income, thus non-cash to the individual tax payor. If the amounts do not appear on the Schedules K-1, then these amounts were cash paid directly to the individual.
Q: Would we see McPherson's interest income of $20,085 in interest expense from Sandover Contractors, Inc.?
A: Very definitely. The interest paid out by Sandover Contractors to Douglas McPherson would be included in the $240,741 of interest expense reported by Sandover Contractors on its accrual income statement and business income tax returns.
Q: Do we adjust line 16 code E loan repayment by the interest amount in schedule B?
A: You would use the unadjusted amount of $86,863. This is the dollar amount of the loan repayment to McPherson in 2018, which is in addition to the $20,085 of interest income received by McPherson for his loans outstanding to the company.
Q: Why would the partnership show recourse and nonrecourse debt and what is the difference? Why would the partner be liable for the nonrecourse?
A: In general, partners in a partnership are responsible for all debt obligations. On the surface, therefore, it makes little sense to separate debt obligations into recourse and non-recourse debt, but it is required for IRS reporting.
Note that no amount is reported for non-recourse debt on Douglas McPherson's Schedule K-1 (Form 1065). However, it is theoretically possible that a partner could arrange an agreement with a company – or related party – that provided a loan to his or her partnership to the effect that he or she would be held harmless in case of default by the company for the loan in question. That is, the debt would be non-recourse to the partner, e.g., Douglas McPherson.
Qualified non-recourse debt usually refers to debt obligations in legal jurisdictions where the lender has the option of seeking relief by attaching the collateral or by requiring the guarantor – the partner or partners – to pay the amount in question.
Finally, recourse debt means that the partner in question is responsible for the full amount reported in case of default.
Q: Can you explain again how you determine living expenses?
A: We use all the available information provided by the guarantor, usually information from his or her personal financial statement. Personal tax returns offer very little information – if any – about personal living expenses.
Note that this is the great unknown area in compiling a personal cash flow statement. At best, any amount reported, or computed, for living expenses is little more than an educated guess based on minimal information. There are no public standards that link personal living expense to taxable or cash income.
Q: Do you use a percentage of wages as part of living expense determination?
A: No. Perhaps a better starting point for estimating living expenses is the savings rate at the time of the personal financial statement. Lately consumers in general save more than 10% of their disposable income, which is the highest the rate has been in years. By implication, 90% of disposable income goes for living expenses, taxes, and debt service. So, you can calculate debt service and taxes and then estimate the living expenses. However, even this very rough ballpark figure provides little guidance as lifestyles and living expenses vary widely.
Once again, we're back to the point that any estimate of living expense is simply an educated guess and may be wildly inaccurate, which means that the resulting estimate of a personal cash flow surplus or deficit may be highly inaccurate. Therefore, better to rely on highly liquid personal assets as the guarantor's source of his or her cash support in a company crisis rather than any surplus cash flow determined based on an estimate of living expenses.
Q: Are session recordings available?
A: Yes. We'll send more information about them to you via email.
Course overview: Personal Income Tax Returns and Cash Flow