Beyond the 1040: Corporation

LINDA KEITH, CPA 4 SECTION Beyond the 1040: Corporation Partnership & LLC Returns S Corporations PC/V1

4-2 BEYOND THE 1040 General information S corporations are sometimes called Subchapter S corporations. For legal purposes they are like any other corporation. The difference is that the shareholders of an S corporation decided to be taxed more like a partnership. Instead of the corporate entity figuring and paying taxes on its income, the income is allocated to the shareholders based on the percentage shares they own. It s a hybrid between a corporation and a partnership from a lender s point of view. Advantages: A newly formed corporation can passthrough losses to its owners that would otherwise go unused for several years. A closely held corporation whose income is primarily from the personal services of its owner can be taxed at a lower rate. The shareholder avoids the double taxation associated with dividends. The company still obtains the advantage of limited liability. Disadvantages: More complicated to form. Cost of forming corporation and corporate returns. Some limitations on size/type of income. May inadvertently lose the election. Tax Forms: Form 1120S US Income Tax Return for an S Corporation Schedule K-1 Tax impact on owner: Owner is taxed on income allocated to him or her in addition to wages received. The word allocation usually means money didn t follow although the shareholder may have taken distributions in addition to the wages. Very similar to a partnership there may be a great difference between cashflow and taxable income. Commercial lenders: Your main interest is if cashflow from operations is sufficient to adequately cover current and proposed debt. Equally important is whether the business appears to be healthy. Watch for major changes or a shift from a stable to a fast-growing or declining business. Commercial lenders often choose not to assume that excess S corporation cashflow will be drawn out in the form of higher shareholder wages or distributions. When doing the analysis for the personal guarantee, your choice. Consumer or mortgage lenders: For low % shareholders, the lender will examine the K-1 to determine if any distributions have been made in addition to wages reported on Page 1 of the 1040. Just because they were last year does not mean they would be again. If there are significant distributions in addition to wages you may want to ask questions. It may be the business sold some assets and had additional cash. As with a regular corporation, you will want to see the full corporate return if your borrower has a higher % interest (controlling shareholder or significant risk of loss) to be sure that wages and distributions are being fueled by business profits rather than borrowing, selling off assets or running down their cash position. And you may be able to give the borrower credit for more than the wages and distributions taken if the corporation is generating additional cashflow. On the other hand, it may be appropriate to count S corporation shortfall against a high % owner who will have to help make up the difference. Sufficient % ownership is determined by your company s guidelines, rather than 51%. I have seen from 15% to 35%. A 25% ownership is commonly used as a cutoff. See page 4-11 for discussion of passive versus nonpassive income or losses. Linda Keith CPA, Inc. February 2012 PC/V1

What Does It Look Like? LINDA KEITH, CPA 4-3 S Corporation K-1 1120S K-1 Information only! WAGES Charitable Contributions Interest/Dividends 1040 A B Actual Cashflow to Shareholder: Use 1040 Wages & K-1 Distributions. Capital Gains/Losses Business Income/Loss Cashflow Available to Shareholder: Use shareholder s share of S Corp Cashflow. PASS-THROUGHS or ALLOCATIONS D E Self Study Students: 1) Refer to the completed worksheets for Bill and Barnum Ann Bailey and for Bailey s Fisheries 1120S (pages 6 & 7 of this section). Follow along as you review each page of the tax return that starts on page 4-8. 2) Section 5 has a case-study with both a partnership and an S corporation, B&J Floors. Do the practice case-study once you have reviewed this section. 3) Compare your completed B&J Floors Worksheet to the solution in section 7. You ll benefit the most if you wait to look at the solution until you have done it on your own. PC/V1 Linda Keith CPA, Inc. February 2012

4-4 Tax BEYOND THE 1040 Form Type PLUS PLUS PLUS (MINUS) EQUALS K-1 Summary worksheet Entity Name 1065 1120S Scorp/ LLC/ GP/ Ltd P % Own 1120S K-1 Distributions 1065 K-1 Withdrawals 1065 K-1 Guaranteed Payments 1065 K-1 Contributions Ln 16 'D' L or 19 Ln 4 L Actual Net cash flow from/(to) entity Use for 1040 Analysis: Yes or No Type of Loan Consumer and mortgage lenders will use the K-1 Summary or the full S Corporation worksheet, depending on your borrower s percentage ownership and whether you want to use actual cashflow or cashflow available. Your guidelines will give you the % cutoff. Mortgage lending typically uses a 25% threshold. I ve seen from 15% up to 50%. Business lenders may also use the K-1 summary when looking at the personal analysis of a guarantor. K-1 Worksheet: This will calculate the actual cashflow from the pass-through entity to the owner. S Corporation Worksheet: The full S Corporation worksheet is necessary to calculate business cashflow and to determine an owner s share of that cashflow. Work the tax return, not the worksheet! Look for the 6 Ns as you go: Nonrecurring Income and Expenses Noncash Income and Deductions Nontaxed Income & Nondeductible Expenses New Income & Expenses Nondocumented Income For Business Cashflow: Start with Sections A, B and C. Determine if cashflow and debt coverage ratio meet your guidelines. If not, don t give up. It may be the owner/guarantor s are taking excess funds out of the company but have excess liquidity in their personal balance sheet. If you are getting their signature, the fact that extra cashflow is not left in the company may not be a barrier. To check cashflow of the owner/guarantor, continue with Section D. For Personal Cashflow Available: You start the same way as the commercial analysis. If you are working on a personal loan, B:14 will be blank. It is for a proposed business loan. Most personal lenders do not use Section C, Debt Coverage Ratio, in their analysis. Excel tm will calculate it anyway. Focus your attention on Section D, where the worksheet subtracts debt from business cashflow to arrive at cashflow available to distribute. Skip D:18 unless your company guidelines require this step. Once you have cashflow available to distribute, you calculate the owner/ guarantor s share. Be sure to make a choice, this figure (D:21) or actual K-1 distributions from the K-1 summary sheet...not both! Linda Keith CPA, Inc. February 2012 PC/V1

S Corporation Case Study worksheet LINDA KEITH, CPA 4-5 A: Form 1120S S Corporation Cashflow Company name and type of business>>> 1 Enter ordinary income (Ln 21) 2 Add back interest expense (Ln 13) 3 Add back depreciation (Ln 14) 4 from Page One, see comments below: 5 from Line 19, see comments below: 6 from Sch K, see comments below: 7 from Sch M-1, see comments below: 8 [Add 1-7] Cashflow Before debt & distributions 9 10 11 B: Annual Debt 12 Enter term debt annual payments 13 Enter LOC/ interest-only payments 14 Enter proposed loan payments 15 Business Cashflow Available to Pay Debt Misc. Subtract distributions to all shareholders (M-2, Ln 7a) Add capital contributed (Increase in Sch L, Lns 22,23) [Combine 8-10] Cashflow Available to Pay Debt Borrower [Add 12 thru 14] Total debt CAUTION: Use either the K-1 Summary (Actual Cashflow to the Owner) OR from this worksheet (Cashflow Available to the Owner)... Page One adjustments: Examples could be nonrecurring income or expenses or unusual bad debts. Line 19, Other Deductions Supporting Schedule 1) Look for this schedule at the end of the tax return with other miscellaneous taxpayer-prepared schedules. 2) Add back nonrecurring items if projecting. 3) Add back noncash amortization. 4) Consider whether the company has adequate insurance. No adjustment necessary if they do. C: Debt Coverage Ratio 16 17 D: [11/(12+13)] DCR Before Proposed Loan [11/15] DCR After Proposed Loan Personal Cashflow to Owner/Guarantor: 18 Optional: Change to required DCR 1.00 19 [8-(15*18)] Cashflow Available to Distribute 20 Enter personal % ownership (K-1, Item A) 21 [19*20] Available Personal Cashflow Use Available Cashflow in Personal Analysis? Yes or No Personal Cashflow to 1040 Pg 1 OR Actual Personal Cashflow: Use K-1 Summary sheet for Actual Cashflow. Don't use both! COMMENTS: Schedule K adjustments: Most Schedule common...line K adjustments: 2: Calculate rental Most common...line cashflow from 2: Calculate Form 8825. rental Line cashflow 4-10: from Historical? Form 8825. Add income, Line 4-10: subtract Historical? losses. Add income, Recurring? Add subtract recurring losses. Recurring? income or Add subtract recurring i income losses. or subtract t recurring Line losses. 11: Ignore...this is depreciation Line that 11: Ignore...this has not yet is depreciation been de-thaducted. has not yet been deducted. Line 12a: Only Only subtract subtract if you if count you count charitable charitable contributions contributions against all other against business entities all other or are business doing entities actual/historical. are doing actual/historical. Schedule M-1 adjustments: Items listed here have not been included elsewhere in this return. Line 3: Historical...Subtract cash outlays. Recurring...Subtract recurring cash outlays. Otherwise ignore. Line 5: Historical...Add cash received. Recurring...Add recurring cash received. Otherwise ignore. PC/V1 Linda Keith CPA, Inc. February 2012

4-6 BEYOND THE 1040 Bailey Completed 1040 Analysis On the next two pages, I have completed a personal 1040 and S corporation analysis for the Baileys. Use them to follow along with the 1040 that starts on page 4-8 and the 1120S that starts on page 4-12. See Sectgion 2 for the Partnership that also feeds into the Bailey s personal analysis. Borrower>>> Bill and Barnum Ann Bailey Prepared by>>> Linda Keith AGI W/ 1.2 DCR Actual K-1 Year>>>> S/A W/ 1.2 DCR Actual K-1 Amount Amount Amount Line Amount Amount Amount 164,896 164,895 164,895 Adjusted Gross Income 37 Adjustments to: Wages 7 48,600 48,600 48,600 C-Corp Owner from W/S Frm 1120 (1,031) (1,031) (1,031) Interest 8a/Sch B 830 830 830 Full Note Payments Received From client Tax-exempt 8b Dividends 9/Sch B State Tax 10 Alimony Received 11 Sch C Business from W/S 12/ Sch C Capital Gains 13/Sch D Other Gains 14 IRA Distributions 15 Pension Distributions 16 Rents, Pships,etc (122,733) (122,733) (122,733) AGI: ALWAYS - gains/+ losses 17 Rental C/F from W/S E, Pg 1 0 0 97,475 K-1 Summary E, Pg 2 0 0 97,475 125,108 121,143 0 Partnership C/F from W/S E, Pg 2 125,108 121,143 0 3,659 (5,061) 0 S Corp C/F from W/S E, Pg 2 3,659 (5,061) 0 Estates/Trusts E, Pg 2 Sch F Farm from W/S 18/Sch F Unemp Comp 19 Social Security 20 Other Income/NOL's 21 Adjustments or Other: ie: AGI Add back All Adj. 23-35 ie: minus 1/2 SE Tax (8,298) (8,298) (8,298) ie: minus Fed/State Tax ie: minus Family Living ie: minus personal debt 169,900 157,214 138,606 Annual Cashflow 169,900 157,215 138,607 14,158 13,101 11,551 Monthly Cashflow 14,158 13,101 11,551 COMMENTS: Column 1: With Available Cashflow from Partnership and SCorporation after business debt paid. Column 2: With Available Cashflow from Partnership and SCorporation after adequate debt covereage of 1.2 DCR. Column 3: Actual Cash to owner/guarantor from the Partnership and SCorporation. Linda Keith CPA, Inc. February 2012 PC/V1

Year: 2009 Bill and Barnum Ann Bailey 0 11,075 86,400 97,475 Bailey Fisheries 1120S Tax Completed S Corporation Cashflow Analysis LINDA KEITH, CPA Form Type PLUS PLUS PLUS MINUS EQUALS 4-7 1065 Scorp/ LLC/ GP/ Ltd 1120S K-1 Distributions 1065 K-1 Withdrawals 1065 K-1 Guaranteed Payments 1065 K-1 Contributions Actual Net cash flow from/(to) entity Entity Name 1120S P % Own Ln 16 'D' '07 L (Prior N) Ln 4 '07 L (Prior N) Bailey Drug Store 1065 GP 60% 11,075 86,400 0 97,475 Bailey Fisheries 1120S Scorp 80% 0 0 Use for 1040 Analysis: Yes or No Company name and type of business>>> Bailey's Fisheries Seafood CAUTION: If you complete the K-1 Summary sheet for a partnership, LLC or S Corporation and also complete the Partnership or S Corpo worksheet, A: Business you run the Cashflow risk of Available including to on Pay 1040 Debt Pg 1 both the actual cashflow DEBT to the * owner/guarantor 1.2 (this form) and the cashflow availab from the 1 other Enter worksheets. ordinary income Notice (Ln you 21) can calculate the actual cashflow (3,115) here, and then (3,115) in the second to the last column, indicate 'no'. Tha 2 Add back interest expense (Ln 13) 20,262 20,262 actual distributions for that entity will not flow to the 1040 Pg 1 and you are free to use cashflow available instead. 3 Add back depreciation (Ln 14) 40,819 40,819 4 from Page One, see comments below: 0 0 I have 5 completed from the Line Bailey's 19, see 1040 comments Pg1 both below: ways, thus did not indicate 999 yes or no on this 999K-1 Worksheet. Misc. 6 from Sch K, see comments below: 399 399 7 from Sch M-1, see comments below: (291) (291) 8 [Add 1-7] Cashflow Before debt & distributions 59,073 59,073 9 Subtract distributions to all shareholders (M-2, Ln 7a) 0 0 10 Add capital contributed (Increase in Sch L, Lns 22,23) 0 0 11 [Combine 8-10] Cashflow Available to Pay Debt 59,073 59,073 B: Annual Debt 12 Enter term debt annual payments 54,499 54,499 13 Enter LOC/ interest-only payments 14 Enter proposed loan payments 15 [Add 12 thru 14] Total debt 54,499 54,499 Borrower C: Debt Coverage Ratio 16 [11/(12+13)] DCR Before Proposed Loan 1.08 1.08 17 [11/15] DCR After Proposed Loan 1.08 1.08 D: 18 Personal Cashflow to Owner/Guarantor: Optional: Enter required DCR 1.20 19 [8-(15*18)] Cashflow Available to Distribute ib t 4,574 (6,326) 20 Enter personal % ownership (K-1, Item A) 80 80 21 [19*20] Available Personal Cashflow 3,659 (5,061) Use Available Cashflow in Personal Analysis? Yes Yes Personal Cashflow to 1040 Pg 1 3,659 (5,061) OR Actual Personal Cashflow: Use K-1 Summary sheet for Actual Cashflow. Don't use both! COMMENTS: Debt ESTIMATED using page one interest $20,262 plus Sch L principal due in next year of $34,237 = $54,499. Line 19: Noncash amortization $999. Sch K Line 4: Add $399 interest income. Sch M-1: Subtract recurring nondeducted meals. Did not subtract fines and penalties. Reviewed prior years. Nonrecurring. Column Two factors in optional required DCR of 1.2 to force adequate debt coverage and show shortfall needed from personal resources for adequate business cashflow. PC/V1 Linda Keith CPA, Inc. February 2012

4-8 BEYOND THE 1040 Bailey 1040 Page one Linda Keith CPA, Inc. February 2012 PC/V1

Bailey W-2 LINDA KEITH, CPA 4-9 The Shareholder s 1040 I have included the owner s 1040 first, to show you how they information from an S corporation flows into the 1040 of the owner. The Baileys have an active interest in both a partnership and an S corporation. Their 1040 starts at left. I have included just a few of the relevant forms from that return. The worksheet packet has AGI method and Schedule Analysis method (SAM) worksheets completed for this return. If you are not in class, use the worksheets on pages 6 & 7. Follow along. Wages...see W-2 Line 5 above. It is also $48,600. AGI: No adjustment. SAM: Use the $48,600. Interest...circle and trace to Schedule B. Rentals, Partnerships, etc...do NOT use the number on the front page, Line 17. It is just a placemarker. AGI: Subtract $122,733 (you would add it back if it were a loss). SAM: Enter zero. Both: Circle the number and trace it to Schedule E on page 4-11. SE tax...guidelines vary. AGI: I made no adjustment. SAM: I subtracted it. Your financial institution may do the opposite. Check your guidelines! PC/V1 Linda Keith CPA, Inc. February 2012

4-10 BEYOND THE 1040 Bailey 1040 Schedule B <<<Might Say K-1 Interest or Interest from a K-1. Note: This software listed the name of the Partnership and S Corporation passing through the K-1 interest. Often, it will simply say K-1 Interest or even Interest from a K-1. In either case, it is noncash in this 1040 and should not be included in recurring personal cashflow. If you cannot tell if it is K-1 pass-through or actual payments from a company, ask. This Schedule B lists the partnership and S Corporation but does not make it clear that the interest is pass-through from a K 1. Often the listing will say Interest from a K 1 or K 1 interest expense. While it is not obvious that it is passthrough, we can confirm that on the K-1. Low % Owner: Exclude pass-through interest and dividends from cashflow. The individual partner or S corporation shareholder did not receive this cash. You will determine their actual cashflow by using withdrawals and guaranteed payments from their K-1. High % Owner: Choice one...exclude pass-through interest/dividends from personal cashflow AND be sure to include it in the cashflow of the partnership or S corporation when you analyze the source entity. Choice two... Include it in personal cashflow. After all, the owner does have access to it if a high enough %. If you do, though, then you cannot add it again when you do the 1065 or 1120S analysis. You ll find it there on Schedule K. With this choice you cannot also use actual cashflow from a K-1. Case study: We ll use choice one. AGI method: Subtract the $1031 interest ($712 Drug Store and $319 Fishery) from cashflow. Schedule Analysis method: Include the $830 interest from the bank. Tax-exempt interest May be listed here but will always be listed on Page 1, Line 8b of the 1040. Use 1040, Line 8b as your source for tax-exempt interest. The Bailey s had none. The tax-exempt interest on Line 8b may include K-1 pass-through interest as well. We will be able to confirm that on the K-1 when we review it. It will be important not to add taxexempt interest at the partnership or S corporation level if you have already included the pass-through in the personal analysis. Linda Keith CPA, Inc. February 2012 PC/V1

Bailey 1040 Schedule E, Page two LINDA KEITH, CPA 4-11 Nonpassive = Business income of active general partner or active S-Corporation shareholder or active LLC Member (Member-Manager) While your guidelines are likely to require that you review all K 1 information, my guess is that in general the greater likelihood of income or risk of loss is on the nonpassive side. Passive = Business/investment income if owner isn t active Includes Limited Partners and can include LLC Members/SCorp shareholders. Generally not guarantors of debt (although they could be) and therefore losses limited to investment in the activity. Passive losses can be misleading, since the real loss may be greater than the deductible loss due to passive loss limitations. The K-1s least likely to be significant are small passive gains from RE and Oil & Gas investments. One of my clients has a guideline that allows ignoring income from any K-1 representing less than 10% of cashflow. (They still subtract the paper loss, though.) PC/V1 Linda Keith CPA, Inc. February 2012

4-12 BEYOND THE 1040 Bailey s fisheries Overview Overview Form 1120S Department of the Treasury Internal Revenue Service For calendar year 2011 or tax year beginning Overview, 2011, ending, A S election effective date Name D Employer identification number 01/01/94 Bailey s Fisheries TYPE 92-7778888 B Business activity code Number, street, and room or suite no. If a P.O. box, see instructions. E Date incorporated Overview number (see instrs) OR 811111 123 Trout Lane 07/07/84 PRINT C Check if Sch M-3 City or town, state, and ZIP code F Total assets (see instructions) attached Bailey WA 98000 $ 317,894. G Is the corporation electing to be an S corporation beginning with this tax year? Yes X No If Yes, attach Form 2553 if not already filed H Check if: (1) Final return (2) Name change (3) Address change (4) Amended return (5) S election termination or revocation Overview I Enter the number of shareholders who were shareholders during any part of the tax year 2 Caution. Include only trade or business income and expenses on lines 1a through 21. See the instructions for more information. 1 a Merchant card and third-party payments. For 2011, enter -0-1 a 0. Overview b Gross receipts or sales not reported on line 1a (see instructions) 1 b 1,013,619. c Total. Add lines 1a and 1b 1 c 1,013,619. I N d Returns and allowances plus any other adjustments (see instructions) 1 d C e Subtract line 1d from line 1c 1 e 1,013,619. O 2 Cost of goods sold (attach Form 1125-A) 2 738,408. M E 275,211. D E D U C TI O N S S E E I N S T R S T A X A N D P A Y M E N T S Sign Here 6 Total income (loss). Add lines 3 through 5 6 Overview 7 Compensation of officers 7 8 Salaries and wages (less employment credits) 8 9 Repairs and maintenance 9 10 Bad debts Overview 10 11 Rents 11 12 Taxes and licenses 12 Overview 13 Interest Debt List 13 14 Depreciation not claimed on Form 1125-A or elsewhere on return (attach Form 4562) Overview 14 15 Depletion (Do not deduct oil and gas depletion.) Equipment List 15 16 Advertising 16 17 Pension, profit-sharing, etc, plans 17 18 Employee benefit programs 18 19 Other deductions (attach statement) See Other * STMT Deductions Statement 19 20 Total deductions. Add lines 7 through 19 20 21 Ordinary business income (loss). Subtract line 20 from line 6 21 22 a Excess net passive income or LIFO recapture tax (see instructions) 22 a b Tax from Schedule D (Form 1120S) 22 b c Add lines 22a and 22b (see instructions for additional taxes) 22 c 23 a 2011 estimated tax payments and 2010 overpayment credited to 2011 23 a b Tax deposited with Form 7004 23 b c Credit for federal tax paid on fuels (attach Form 4136) 23 c d Add lines 23a through 23c 23 d 24 Estimated tax penalty (see instructions). Check if Form 2220 is attached 24 25 Amount owed. If line 23d is smaller than the total of lines 22c and 24, enter amount owed 25 26 Overpayment. If line 23d is larger than the total of lines 22c and 24, enter amount overpaid 26 27 Enter amount from line 26 Credited to 2012 estimated tax Refunded 27 Paid Preparer Use Only Under penalties of perjury, I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief, it is true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge. May the IRS discuss this return with the preparer shown below President (see instructions)? A Signature of officer Date A Title Yes No Print/Type preparer s name Preparer s signature Date Check if PTIN Firm s name Firm s address G U.S. Income Tax Return for an S Corporation OMB No. 1545-0130 G Do not file this form unless the corporation has filed or is attaching Form 2553 to elect to be an S corporation. 2011 G See separate instructions. 3 Gross profit. Subtract line 2 from line 1e 3 4 Net gain (loss) from Form 4797, Part II, line 17 (attach Form 4797) 4 5 Other income (loss) (see instrs ' att statement) 5 Self-Prepared self-employed Firm s EIN G 275,211. 48,600. 16,200. 52,058. 21,492. 13,534. 20,262. 40,819. Phone no. BAA For Paperwork Reduction Act Notice, see separate instructions. SPSA0112 12/12/11 Form 1120S (2011) 405. 64,956. 278,326. -3,115. Linda Keith CPA, Inc. February 2012 PC/V1

1120S, Page One LINDA KEITH, CPA 4-13 This is a hybrid between a corporation return and a partnership return. It most resembles a partnership return. The front page of the 1120S is similar to the Schedule C and the front pages of the 1065 and the 1120 (corporate return). The same analysis applies: Is it a significant source of income or risk for the borrower? Consider type of business, gross receipts and total wages to get a feel for the business. What kind of equipment do they have, how old, how much? How long have they been in business? Does the corporation generate enough cashflow from operations to service debt? Commercial lenders might prepare a Statement of Cashflows Worksheet (Section 5) to determine the source other than operations of their cashflow. It will also show how cashflow was used. Overview Pg 2 Sch B Ln 1 If cash basis, be careful drawing conclusions from comparison of years. If accrual, OK to compare. Pg 2 Sch B Ln 2 What type of business? Pg 1 Top Fiscal or calendar year Pg 1 Box A Date of S Corp election. Helps to see if an initial return is a full year. Pg 1 Box E Date incorporated Pg 1 Ln G/H Final return... They may have simply changed entity type. If so, you may be looking at a partial year and they may still be in business. Pg 1 Ln I # of shareholders Pg 1 Ln 1c Gross receipts Pg 1 Ln 7 Compensation of officers Pg 1 Ln 8 Salaries & wages 11 Form 1125-A or 10 Pg 2 Sch A Ln 3 Cost of Labor Pg 1 Ln 11 Rents Pg 1 Ln 13 Interest (need debts...for this case study we will use the shortcut described at right.) Pg 1 Ln 14 Depreciation...Review equipment list if attached for size/scope of business and if they are replacing as a healthy business would be. Source of Adjustments: 1st) Page One 2nd) Other Deductions Schedule [Ln 19] 3rd) Schedule K [Lines 2-11a] 4th) Schedule M-1 [Lines 3 & 5] 5th) Schedule M-2 [Commercial only] General Cashflow Formula: Start Line 21 Ordinary Income Plus Line 13 Interest ^ Minus Borrower* Loan payments ^* Plus Line 14 Depreciation Commercial lenders only: Minus M-2, Ln 7 Distributions ^Shortcut for debt... two choices: 1) Estimate debt after adding back interest: Page 1, Line 13 Interest Sch L, Line 17, Col (d) + ESTIMATED DEBT PMTS = 2) OR Do not add back interest and subtract principal (Schedule L, Line 17, Column d). *Debt Coverage: Do not subtract debt. Additional Line-by-Line Instructions: 1a. Compare to prior years. 2. Compare COGS% to prior years. 4. G/L disposal of assets or business casualty loss. If casualty loss, impact on future cashflow? Adequate insurance? 9. Compare to prior years. Decline could mean cashflow problems if they haven t replaced older equipment. 10. Bad debts. Accrual basis only. Cash basis shows less revenue if customer doesn t pay. If significant & nonrecurring, consider if it is a write-off of old receivables. Noncash or nonrecurring? 12. Enough? (At least 10-40% of Line 7) 13. Add back interest and subtract loan payments, including line-of-credit interest and proposed payments. (We will use the shortcut.)^* 14. Add back depreciation. 17. Add back if optional. 19. Trace to supporting schedule. Is there adequate insurance? Add back amortization and nonrecurring items. PC/V1 Linda Keith CPA, Inc. February 2012

4-14 BEYOND THE 1040 Bailey s Fisheries Overview Overview Form 1125-A Cost of Goods Sold (December 2011) OMB No. 1545-2225 Department of the Treasury G Attach to Form 1120, 1120-C, 1120-F, 1120-S, 1065, and 1065-B. Internal Revenue Service Name Employer identification number Bailey s Fisheries 92-7778888 1 Inventory at beginning of year 1 2 Purchases 2 3 Cost of labor Overview 3 4 Additional section 263A costs (attach schedule) 4 5 Other costs (attach schedule) See * Schedule STMT A, Other Costs Statement 5 6 Total. Add lines 1 through 5 6 7 Inventory at end of year 7 738,408. 738,408. 8 Cost of goods sold. Subtract line 7 from line 6. Enter here and on Form 1120, page 1, line 2 or the appropriate line of your tax return (see instructions) 8 738,408. 9 a Check all methods used for valuing closing inventory: (i) Cost (ii) Lower of cost or market (iii) Other (Specify method used and att. expl.) b Check if there was a writedown of subnormal goods c Check if the LIFO inventory method was adopted this tax year for any goods (if checked, attach Form 970) d If the LIFO inventory method was used for this tax year, enter amount of closing inventory computed under LIFO 9d e If property is produced or acquired for resale, do the rules of section 263A apply to the corporation? Yes No f Was there any change in determining quantities, cost, or valuations between opening and closing inventory? If Yes, attach explanation Yes No BAA For Paperwork Reduction Act Notice, see separate instructions. Form 1125-A (12-2011) Form 1120S (2011) Bailey s Fisheries 92-7778888 Page 2 Schedule B Other Information (see instructions) Yes No 1 Check accounting method: a X Cash b Accrual c Other (specify) 2 See the instructions and enter the: a Business activity Commercial Fishing b Product or service Seafood 3 At the end of the tax year, did the corporation own, directly or indirectly, 50% or more of the voting stock of a domestic corporation? (For rules of attribution, see section 267(c).) If Yes, attach a statement showing: (a) name and employer identification number (EIN), (b) percentage owned, and (c) if 100% owned, was a qualified subchapter S subsidiary election made? 4 Has this corporation filed, or is it required to file, Form 8918, Material Advisor Disclosure Statement, to provide information on any reportable transaction? 5 Check this box if the corporation issued publicly offered debt instruments with original issue discount If checked, the corporation may have to file Form 8281, Information Return for Publicly Offered Original Issue Discount Instruments. X X Overview Add if recurring... see notes at right. 6 If the corporation: (a) was a C corporation before it elected to be an S corporation or the corporation acquired an asset with a basis determined by reference to the basis of the asset (or the basis of any other property) in the hands of a C corporation and (b) has net unrealized built-in gain in excess of the net recognized built-in gain from prior years, enter the net unrealized built-in gain reduced by net recognized built-in gain from prior years (see instructions) G $ 7 Enter the accumulated earnings and profits of the corporation at the end of the tax year $ 8 Are the corporation s total receipts (see instructions) for the tax year and its total assets at the end of the tax year less than $250,000? If Yes, the corporation is not required to complete Schedules L and M-1 9 During the tax year, was a qualified subchapter S subsidiary election terminated or revoked? If Yes, see instructions 10a Did the corporation make any payments in 2011 that would require it to file Form(s) 1099 (see instructions)? X b If Yes, did the corporation file or will it file all required Forms 1099? X Schedule K Shareholders Pro Rata Share Items Total amount 1 Ordinary business income (loss) (page 1, line 21) Do not use...already on Page One. 1-3,115. 2 Net rental real estate income (loss) (attach Form 8825) 2 3 a Other gross rental income (loss) 3 a Cashflow rentals & add b Expenses from other rental activities (attach statement) 3 b I c Other net rental income (loss). Subtract line 3b from line 3a 3 c to worksheet N C 4 Interest income 4 399. O M 5 Dividends: a Ordinary dividends 5 a E b Qualified dividends 5 b L O S S 6 Royalties 6 7 CPCZ0401 01/25/12 Net short-term capital gain (loss) (attach Schedule D (Form 1120S)) 7 8 a Net long-term capital gain (loss) (attach Schedule D (Form 1120S)) 8 a b Collectibles (28%) gain (loss) c Unrecaptured section 1250 gain (attach statement) 9 Net section 1231 gain (loss) (attach Form 4797) 9 10 Other income (loss) (see instructions) Type 10 Linda Keith CPA, Inc. February 2012 PC/V1 8 b 8 c X X Form 1120S (2011)

1120S, Page Two LINDA KEITH, CPA 4-15 2011 Form 1125-A or 2010 Schedule A Cost of Goods Sold In 2011, IRS moved COGS to 1125-A. As with corporation and partnership COGS, of particular interest is a dramatic change in inventory. Generally, the trend in inventory should mirror the trend in sales. A jump in inventory should usually be accompanied by an increase in sales. If not, they are building up inventory. Inventory buildup uses cashflow generated by the business because the money is tied up in inventory until the goods are sold and the receivables collected. If this trend continues, not all of the cashflow generated by operations is available to the shareholders in the form of wages or distributions, or to the business to service debt, unless they are financing the buildup through borrowing or capital contributions. On the other hand, a severe drop in inventory could signal cashflow problems. Is it a permanent drop? Did they have a year-end sale that has been made up in beginning of the year purchases? If not, will it be? Did the supplier move to a closer location? Did the company adopt just-in-time inventory methods that allow it to run on lower inventory levels? Schedule B: Other Information Only four of the eight items are usually of interest. Item 1: Cash basis means that income is recognized when received and expenses are recognized when paid. This is very close to what is happening in their checkbook, but may not accurately reflect how much their business activity earned them during the year. For example, if a cash basis company receives deposits on contracts in December, but does the work in January, the earlier year income will be overstated and the later year will be understated. The biggest problem with this is if the lender thinks the business is declining and has concerns about it. Before you draw conclusions about PC/V1 declining or growing businesses, check Schedule B, Line 1. If it is cash basis, you cannot draw a conclusion. Item 2: Type of business. Item 3: If this corporation is closely held by your borrower and it owns part of another corporation, consider the need to request that corporation s tax returns. Item 8: If total receipts and assets are less than $250,000 you may not have a Schedule L (used for the debt shortcut) or an M-1 (used for nondeductible expenses and nontaxed income). Schedule K: Shareholders Shares The S corporation, like the partnership, is a pass-through entity. All income, deduction and credit items retain their character as they pass from the business return into the personal return. Schedule K is the parent to the K-1s. Lines 2 & 4 are the most likely source of significant cashflow adjustments. Line 1 Ordinary Income (loss) No need to do anything with this since it is taken care of with Page 1 review. Line 2 Rental income/loss Use the rental schedule of the 1040 cashflow worksheet to determine rental cashflow. Be sure to add back depreciation on the 8825 even though you have already added depreciation back on page one of the 1120S. Rental depreciation is not included. Then bring the rental cashflow to the S corporation worksheet instead of 1040 Page 1 so the individual owner only gets credit for his/her share. Line 3 Other rental activities Add 3c plus any depreciation on the supporting schedule to 3b. Lines 4-10 represent cashflow to the S corporation and is not reported on Page One of the 1120S. For historical add these items to cashflow. For recurring cashflow, add only if recurring. Case study: Add $399 to Line 6 of the corporate cashflow worksheet. Linda Keith CPA, Inc. February 2012

4-16 BEYOND THE 1040 Bailey s Fisheries Minus if recurring. See notes at right. Foreign Transactions 14 a Name of country or U.S. possession b Gross income from all sources 14 b c Gross income sourced at shareholder level 14 c Foreign gross income sourced at corporate level d Passive category 14 d e General category 14 e f Other (attach statement) 14 f Deductions allocated and apportioned at shareholder level g Interest expense 14 g h Other 14 h Deductions allocated and apportioned at corporate level to foreign source income i Passive category 14 i j General category 14 j k Other (attach statement) 14 k Other information l Total foreign taxes (check one): G Paid Accrued 14 l m Reduction in taxes available for credit (attach statement) 14 m n Other foreign tax information (attach statement) Alternative 15 a Post-1986 depreciation adjustment 15 a Minimum b Adjusted gain or loss 15 b c Depletion (other than oil and gas) 15 c Tax (AMT) d Oil, gas, and geothermal properties ' gross income 15 d Items e Oil, gas, and geothermal properties ' deductions 15 e f Other AMT items (attach statement) 15 f Items 16 a Tax-exempt interest income 16 a Affecting b Other tax-exempt income 16 b Shareholder c Nondeductible expenses 16 c Basis d Distributions (attach stmt if required) (see instrs) 16 d e Repayment of loans from shareholders 16 e Other 17 a Investment income 17 a Information b Investment expenses 17 b c Dividend distributions paid from accumulated earnings and profits 17 c d Other items and amounts (attach statement) Form 1120S (2011) Bailey s Fisheries 92-7778888 Page 3 Shareholders Pro Rata Share Items (continued) Total amount Deductions 11 Section 179 deduction (attach Form 4562) Depreciation. 11 12 a Contributions Optional? Check guidelines 12 a b Investment interest expense 12 b c Section 59(e)(2) expenditures (1) Type (2) Amount 12 c (2) d Other deductions (see instructions) Type 12 d Credits 13 a Low-income housing credit (section 42(j)(5)) 13 a b Low-income housing credit (other) 13 b c Qualified rehabilitation expenditures (rental real estate) (attach Form 3468) 13 c d Other rental real estate credits (see instrs) Type 13 d e Other rental credits (see instrs) Type 13 e f Alcohol and cellulosic biofuel fuels credit (attach Form 6478) 13 f g Other credits (see instructions) Type 13 g Reconciliation 18 Income/loss reconciliation. Combine the amounts on lines 1 through 10 in the far right column. From the result, subtract the sum of the amounts on lines 11 through 12d and lines 14l 18 2,995. -2,716. BAA Form 1120S (2011) 399. SPSA0134 06/03/11 Linda Keith CPA, Inc. February 2012 PC/V1

1120S, Page Three LINDA KEITH, CPA 4-17 Line 11 Section 179 expense deductions Ignore. This is depreciation which was not subtracted on Page 1 of the 1120S S corporation return. Line 12a Charitable contributions I ignore since it is optional. However, if you do not add back charitable contributions for corporations you should subtract this. Line 12b - d Subtract if significant & recurring. Note: Line 12b Investment Interest may already be taken into consideration in the debt list from your borrower. However, it is interest expense over and above that reported on Page One of the 1120S S corporation return. If it is similar to margin interest on a stock broker account and it is recurring, subtract it. Expansion? If portfolio income is material, I would wonder why. Most companies don t have cash sitting around in idle investments unless they are getting ready to do something. If interest or dividends are significant, consider if the company is expanding. Remember that a company in expansion can have a higher risk profile than a stable one. Ignore the rest! The remaining lines of Schedule K either are used by the tax preparer to accurately complete the 1040 tax return or are included elsewhere in the S Corporation tax return. I do not use them in my analysis. Often no entries from Schedule K: If the S corporation has no rentals and portfolio income is either immaterial or already included as pass-through in a high % owner s 1040 analysis, you may not have any entry from Schedule K. PC/V1 Linda Keith CPA, Inc. February 2012

4-18 BEYOND THE 1040 Bailey s Fisheries Form 1120S (2011) Bailey s Fisheries 92-7778888 Page 4 Schedule L Balance Sheets per Books Beginning of tax year End of tax year Assets (a) (b) (c) (d) 1 Cash 12,193. 12,043. 2 a Trade notes and accounts receivable b Less allowance for bad debts 3 Inventories 4 U.S. government obligations 5 Tax-exempt securities (see instructions) 6 Other current assets (attach stmt) Ln 6 St 72,171. 7,092. 7 Loans to shareholders 8 Mortgage and real estate loans 9 Other investments (attach statement) 10 a Buildings and other depreciable assets b Less accumulated depreciation 11 a Depletable assets b Less accumulated depletion 12 Land (net of any amortization) 13 a Intangible assets (amortizable only) b Less accumulated amortization 14 Other assets (attach stmt) 15 Total assets Liabilities and Shareholders Equity 16 Accounts payable 17 Mortgages, notes, bonds payable in less than 1 year 18 Other current liabilities (attach stmt) 19 Loans from shareholders 20 Mortgages, notes, bonds payable in 1 year or more 21 Other liabilities (attach statement) 22 Capital stock 23 Additional paid-in capital 24 Retained earnings 25 Adjustments to shareholders equity (att stmt) 1,308,968. 1,475,265. 1,136,194. 172,774. 1,177,012. 298,253. 760. 1,620. 115. 645. 1,114. 506. 257,783. 317,894. 0. 69,956. 40,422. 34,237. 356,407. 358,458. 36,450. 36,450. 4,050. 4,050. -179,546. -185,257. 26 Less cost of treasury stock 27 Total liabilities and shareholders equity 257,783. 317,894. Schedule M-1 Reconciliation of Income (Loss) per Books With Income (Loss) per Return Note. Schedule M-3 required instead of Schedule M-1 if total assets are $10 million or more ' see instructions 1 Net income (loss) per books -5,711. 5 Income recorded on books this year not included Add (recurring) cash 2 Income included on Schedule K, lines 1, 2, 3c, 4, 5a, 6, 7, on Schedule K, lines 1 through 10 (itemize): received, otherwise 8a, 9, and 10, not recorded on books this year (itemize): a Tax-exempt interest $ ignore. ^Principal Due in Next Twelve Months 3 Expenses recorded on books this year not included on Schedule K, lines 1 through 12, and 14l (itemize): a Depreciation $ b Travel and entertainment $ 291. Ln * 3 STMT Stmt 2,704. 4 Add lines 1 through 3 Schedule M-2 6 Deductions included on Schedule K, lines 1 through 12, and 14l, not charged against book income this year (itemize): a Depreciation $ 2,995. 7 Add lines 5 and 6-2,716. 8 Income (loss) (Schedule K, ln 18). Ln 4 less ln 7-2,716. Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholders Undistributed Taxable Income Previously Taxed (see instructions) 1 Balance at beginning of tax year 2 Ordinary income from page 1, line 21 3 Other additions * STMT 4 Loss from page 1, line 21 5 Other reductions * STMT 6 Combine lines 1 through 5 7 Distributions other than dividend distributions 8 Balance at end of tax year. Subtract line 7 from line 6 Subtract (recurring) cash spent, otherwise ignore. (a) Accumulated adjustments account -179,546. 399. 3,115. 2,995. -185,257. -185,257. (b) Other adjustments account (c) Shareholders undistributed taxable income previously taxed <Com l Subtract: Will not always be full distributions SPSA0134 06/03/11 Form 1120S (2011) Linda Keith CPA, Inc. February 2012 PC/V1

1120S, Page Four LINDA KEITH, CPA 4-19 Schedule L: Balance Sheets See page 3-21 for a discussion of what you can learn from balance sheets. Do you find it interesting they have accounts payable in a cash-basis return? That is because the balance sheets are per books, not per return. It is not uncommon to have cashbasis tax returns and accrual-basis books and records. Shortcut for debt: Schedule L, Line 17, column (d) principal due in the next 12 months can be used in debt estimates. This will not be a good estimate when: 1) Debt levels are changing; 2) Line 17 includes a balance on a commercial line of credit; or 3) Line 17 does not include current portion of long-term debt. In our solution, I used the shortcut and estimated debt by adding the interest from the front page ($20,262) to the principal due in the next twelve months ($34,237) for a total debt of $54,499. Whenever you estimate debt instead of obtaining actual figures, be sure to show your calculations on the worksheet. Schedule M-1: Reconciliation This schedule is a source of nontaxed income and nondeductible expenses. Any items reported on the M-1 have not been reported on Page One or the Other Deductions (Line 19) Schedule. Therefore, if they are noncash items (or nonrecurring if you are projecting cashflow), you can safely ignore them. Alternate method: Some financial institutions start the cashflow analysis with M-1, Line 1 instead of the bottom line of Page One. In that case, you will need to make adjustments for all noncash and nonrecurring items on all lines of the M-1. Line 3: Subtract (recurring) cash spent, otherwise ignore these items. Bailey s Fisheries shows expenses on its books that did not reduce taxable income. Any depreciation listed on Line 3a is a noncash item. Since it is reported on the M-1 (rather than front page) and is not recurring cash spent, I would ignore it. The $291 on Line 3b is nondeducted meals and should be subtracted from cashflow. The $2,704 is described on the attached schedule (page 4-24) as fines & penalties. This is a tough one. If you are projecting cashflow, it only needs your attention if you are digging for dollars and $2,704 will make a difference. Look to other years to see if it was recurring. A lender from Ballard, WA who works with a lot of fishers and fisheries said it was unlikely to be recurring because it can affect your license. A lender from Astoria, OR says she sees it all the time. I did not subtract it in the solutions. Line 5: Add (recurring) cash received. Otherwise, ignore these items. A difference between the S corporation and a regular corporation cashflow approach: The borrower s share of taxexempt interest has already found its way to Form 1040, Line 8b by way of the K-1. If you are doing a personal analysis and have added the tax-exempt interest from Line 8b to the personal cashflow, do not also add tax-exempt interest from the M -1, Line 5 to S corporation cashflow. [NOTE: You are likely to have included pass-through K 1 tax exempt interest in the 1040 because it is not required to be itemized.] Schedule M-2: Analysis Commercial lenders may subtract the distributions on Line 7. Compare years to decide if it is recurring. It is common for shareholders of closely-held S Corporations to take a significant part of their compensation as distributions rather than wages to reduce payroll taxes. The S Corporation return does not spell out capital contributions by owners. However, you can compare Sch L Lines 22 and 23, Capital Stock and Paid-in-capital, between the beginning and end of year to see if the owners contributed. Add it. PC/V1 Linda Keith CPA, Inc. February 2012

4-20 BEYOND THE 1040 Bailey s Fisheries Schedule K-1 2011 (Form 1120S) For calendar year 2011, or tax Department of the Treasury Internal Revenue Service year beginning, 2011 ending, Shareholder s Share of Income, Deductions, Credits, etc G See page 2 of form and separate instructions. Part I Information About the Corporation A Corporation s employer identification number 92-7778888 B Corporation s name, address, city, state, and ZIP code Bailey s Fisheries 123 Trout Lane Bailey, WA 98000 Final K-1 Amended K-1 OMB No. 1545-0130 Part III Shareholder s Share of Current Year Income, Deductions, Credits, and Other Items 1 Ordinary business income (loss) 13 Credits -2,492. 2 Net rental real estate income (loss) 3 Other net rental income (loss) 4 Interest income 5 a Ordinary dividends 5 b Qualified dividends 14 Foreign transactions 6 Royalties 319. 671111 C D E IRS Center where corporation filed return Ogden, UT 84201-0013 Part II Information About the Shareholder Shareholder s identifying number 888-77-6666 Shareholder s name, address, city, state, and ZIP code Bill Bailey 747 Stone Ave Bailey, WA 98000 7 Net short-term capital gain (loss) 8 a Net long-term capital gain (loss) 8 b Collectibles (28%) gain (loss) 8 c Unrecaptured section 1250 gain 9 Net section 1231 gain (loss) 10 Other income (loss) 15 Alternative minimum tax (AMT) items F Shareholder s percentage of stock ownership for tax year 80.00000 % F O R I R S U S E O N L Y Distributions will be listed on Line 16 with a code of D. 11 Section 179 deduction 16 Items affecting shareholder basis C 2,396. 12 Other deductions 17 Other information A 319. *See attached statement for additional information. BAA For Paperwork Reduction Act Notice, see Instructions for Form 1120S. Schedule K-1 (Form 1120S) 2011 SPSA0412 08/02/11 Linda Keith CPA, Inc. February 2012 PC/V1

1120S, Schedule K-1 LINDA KEITH, CPA 4-21 Schedule K-1: Shareholder s Share This is part of the 1120S, not the 1040. It is similar to the 1065 K-1 for partners in that its purpose is to pass-through items of Income, Credits, and Deductions to the shareholder while retaining their character. Question F: Look here to determine if your borrower/ shareholder has enough % ownership to require review of the full 1120S. Top of right column: Notice if this is the final K-1. We are looking for continuing cashflow to this borrower. Line 16, Code D: This is where distributions of cash or property will be shown. Distributions in addition to wages are often significant and continuing. They may be taking some compensation as distributions instead of wages to minimize payroll taxes. Where did it go? The next page (back of the K-1) is your cheat sheet for where these entries end up on a 1040. See also the Bailey s 1040 on pages 4-8 through 4-11 to see how the K-1 items flowed to their personal return. Finally, the K-1 could flow into a Partnership (1065), a corporation (1120) or another S Corporation (1120S). PC/V1 Linda Keith CPA, Inc. February 2012

4-22 BEYOND THE 1040 Bailey s Fisheries Schedule K-1 (Form 1120S) 2011 Bailey s Fisheries 92-7778888 Page 2 This list identifies the codes used on Schedule K-1 for all shareholders and provides summarized reporting information for shareholders who file Form 1040. For detailed reporting and filing information, see the separate Shareholder s Instructions for Schedule K-1 and the instructions for your income tax return. 1 Ordinary business income (loss). Determine whether the income (loss) is passive Code Report on or nonpassive and enter on your return as follows: M Credit for increasing research activities Report on N Credit for employer social security and Medicare taxes Passive loss O Backup withholding Form 1040, line 62 Passive income Schedule E, line 28, column (g) P Other credits Nonpassive loss Schedule E, line 28, column (h) Nonpassive income Schedule E, line 28, column (j) 2 Net rental real estate income (loss) 3 Other net rental income (loss) Net income Schedule E, line 28, column (g) Net loss 4 Interest income Form 1040, line 8a 5 a Ordinary dividends Form 1040, line 9a 5 b Qualified dividends Form 1040, line 9b 6 Royalties Schedule E, line 3b 7 Net short-term capital gain (loss) Schedule D, line 5 8 a Net long-term capital gain (loss) Schedule D, line 12 8 b Collectibles (28%) gain (loss) 28% Rate Gain Worksheet, line 4 (Schedule D instructions) 8 c Unrecaptured section 1250 gain 9 Net section 1231 gain (loss) 10 Other income (loss) Code A Other portfolio income (loss) B Involuntary conversions C Section 1256 contracts and straddles Form 6781, line 1 D Mining exploration costs recapture See Pub 535 E Other income (loss) 11 Section 179 deduction 12 Other deductions A Cash contributions (50%) B Cash contributions (30%) C Noncash contributions (50%) D Noncash contributions (30%) See the Shareholder s Instructions E Capital gain property to a 50% organization (30%) F Capital gain property (20%) G Contributions (100%) H Investment interest expense Form 4952, line 1 I Deductions ' royalty income Schedule E, line 19 J Section 59(e)(2) expenditures K Deductions ' portfolio (2% floor) Schedule A, line 23 L Deductions ' portfolio (other) Schedule A, line 28 M Preproductive period expenses N Commercial revitalization deduction from rental real estate activities See Form 8582 instructions O Reforestation expense deduction P Domestic production activities information See Form 8903 instructions Q Qualified production activities income Form 8903, line 7b R Employer s Form W-2 wages Form 8903, line 17 S Other deductions 13 Credits A Low-income housing credit (section 42(j)(5)) from pre-2008 buildings B Low-income housing credit (other) from pre-2008 buildings C Low-income housing credit (section 42(j)(5)) from post-2007 buildings See the Shareholder s D Low-income housing credit (other) from Instructions post-2007 buildings E Qualified rehabilitation expenditures (rental real estate) F Other rental real estate credits G Other rental credits H Undistributed capital gains credit Form 1040, line 71, box a I Alcohol and cellulosic biofuel fuels credit J Work opportunity credit K Disabled access credit L Empowerment zone and renewal community employment credit See the Shareholder s Instructions SPSA0412 08/02/11 14 Foreign transactions A Name of country or U.S. possession B Gross income from all sources Form 1116, Part I C Gross income sourced at shareholder level Foreign gross income sourced at corporate level D Passive category E General category Form 1116, Part I F Other Deductions allocated and apportioned at shareholder level G Interest expense Form 1116, Part I H Other Form 1116, Part I Deductions allocated and apportioned at corporate level to foreign source income I Passive category J General category Form 1116, Part I K Other Other information L Total foreign taxes paid Form 1116, Part II M Total foreign taxes accrued Form 1116, Part II N Reduction in taxes available for credit Form 1116, line 12 O Foreign trading gross receipts Form 8873 P Extraterritorial income exclusion Form 8873 Q Other foreign transactions 15 Alternative minimum tax (AMT) items A Post-1986 depreciation adjustment B Adjusted gain or loss C Depletion (other than oil & gas) See the Shareholder s Instructions and the D Oil, gas, & geothermal ' gross income Instructions for Form 6251 E Oil, gas, & geothermal ' deductions F Other AMT items 16 Items affecting shareholder basis A Tax-exempt interest income Form 1040, line 8b B Other tax-exempt income C Nondeductible expenses D Distributions E Repayment of loans from shareholders 17 Other information A Investment income Form 4952, line 4a B Investment expenses Form 4952, line 5 C Qualified rehabilitation expenditures (other than rental real estate) D Basis of energy property E Recapture of low-income housing credit (section 42(j)(5)) Form 8611, line 8 F Recapture of low-income housing credit (other) Form 8611, line 8 G Recapture of investment credit See Form 4255 H Recapture of other credits I Look-back interest ' completed long-term contracts See Form 8697 J Look-back interest ' income forecast method See Form 8866 K Dispositions of property with section 179 deductions L Recapture of section 179 deduction M Section 453(l)(3) information N Section 453A(c) information O Section 1260(b) information P Interest allocable to production expenditures See the Shareholder s Q CCF nonqualified withdrawals Instructions R Depletion information ' oil and gas S Amortization of reforestation costs T Section 108(i) information U Other information See the Shareholder s Instructions Schedule K-1 (Form 1120S) 2011 Linda Keith CPA, Inc. February 2012 PC/V1

1120S, Form 8825 LINDA KEITH, CPA 4-23 Form 8825 (Rev. December 2010) Department of the Treasury Internal Revenue Service Name Rental Real Estate Income and Expenses of a Partnership or an S Corporation See instructions on back. Attach to Form 1065, Form 1065-B, or Form 1120S. OMB No. 1545-1186 Employer identification number 1 Show the type and address of each property. For each rental real estate property listed, report the number of days rented at fair rental value and days with personal use. See instructions. See page 2 to list additional properties. Physical address of each property street, city, Type Enter code 1-8; Fair Rental Days Personal Use Days state, ZIP code see page 2 for list A B C D Properties Rental Real Estate Income A B C D 2 Gross rents....... 2 Rental Real Estate Expenses 3 Advertising....... 3 4 Auto and travel..... 4 5 Cleaning and maintenance.. 5 6 Commissions...... 6 7 Insurance....... 7 8 Legal and other professional fees 8 9 Interest........ 9 10 Repairs........ 10 11 Taxes........ 11 12 Utilities........ 12 13 Wages and salaries.... 13 14 Depreciation (see instructions) Form 8825 14 Rental Real Estate 15 Other (list) Cashflow this just like the rentals on Schedule 15 E of the personal 1040. Include the rental cashflow as additional adjustments on the worksheet and 16 Total expenses for each property. Add lines 3 through 15... 16 17 Income or (Loss) from explain. each property. Subtract line 16 from line If 2you 17 are using the Rentals eworksheet, 18a Total gross rents. Add gross be rents sure from you line 2, route columns the A rental through H cashflow.... to...... 18a b Total expenses. Add total expenses from line 16, columns A through H......... 18b ( ) the S Corporation page as an additional 19 Net gain (loss) from Form 4797, Part II, line 17, from the disposition of property from rental real estate activities... adjustment...... instead... of.. 1040.. page... 1 so.. the...... 19 20a Net income (loss) from rental shareholder real estate activities only gets from partnerships, his/her share estates, of and the trusts in which this partnership or S corporation cashflow/shortfall. is a partner or beneficiary (from Schedule K-1)...... 20a b Identify below the partnerships, estates, or trusts from which net income (loss) is shown on line 20a. Attach a schedule if more space is needed: (1) Name (2) Employer identification number 21 Net rental estate income (loss). Combine lines 18a through 20a. Enter the result here and on: Form 1065 or 1120S: Schedule K, line 2, or Form 1065-B: Part I, line 4 For Paperwork Reduction Act Notice, see back of form. Cat. No. 10136Z Form 8825 (12-2010) 21 PC/V1 Linda Keith CPA, Inc. February 2012

4-24 BEYOND THE 1040 Bailey s Fisheries Bailey s Fisheries 92-7778888 1 Form 1120S, Page 1, Line 19 Other Deductions Amortization Automobile and truck expense Dues and subscriptions Insurance Meals and entertainment (50%) Office expense Supplies Telephone Utilities Professional Fees License & fees Total 999. 744. 3,043. 47,832. 291. 117. 228. 680. 1,577. 6,802. 2,643. 64,956. Always look for noncash and nonrecurring expenses to add back. Also consider if insurance is adequate. We ll see Schedule M1 later for nondeducted expenses rather than using the $291 from this schedule. Other Current Assets: 1120S, Schedule L, Line 6 Beginning of End of Other Current Assets: tax year tax year Plant Receivables Stock Sub Rec Prepaid insurance Total 62,454. 9,717. 72,171. 7,092. 7,092. Form 1120S, Page 4, Schedule M-1, Line 3 Sch M-1, Line 3 Fines & penalties 2,704. Total 2,704. Form 1120S, Page 4, Schedule M-2, Line 3 Schedule M-2, Other Additions Interest income 399. Total 399. Form 1120S, Page 4, Schedule M-2, Line 5 Schedule M-2, Other Reductions Meals and entertainment Fines & penalties Total 291. 2,704. 2,995. Linda Keith CPA, Inc. February 2012 PC/V1

1120S Supporting Schedules LINDA KEITH, CPA 4-25 Bailey s Fisheries 92-7778888 2 Form 1125, Line 5 Other Costs Statement Crewshares Fuel Provisions Observer Fees Gear & Supplies Crew Rotation Total 359,839. 220,575. 12,924. 9,973. 124,656. 10,441. 738,408. At the back of the tax return there may be many additional schedules, generally in the order of the lines they support. These should accompany any line in the return that requires (attached schedule). If they are important or material, you should have come back to look at them earlier. It doesn t hurt to peruse these schedules when you think you are done reviewing the return in case there is something material you should ask about. Form 1120S, Page 1, Line 19 Other Deductions Always trace other deductions to the supporting schedule. Be sure they have adequate insurance. You may also find amortization or nonrecurring expenses to add back to the bottom line. The $64,956 has been deducted from income on the front page of the 1120S. The way to spot nonrecurring expenses is by their title (moving expense) or by comparing the two most recent years. Look harder for nonrecurring expenses to add back on a loan where it looks good otherwise but you are having trouble coming up with enough cashflow. It is not as critical to search for add-backs when your borrower is qualifying easily for the loan without increased qualifying income. I added back the $999 amortization. Form 1120S, Page 4, Sch M-1, Line 3 You will have traced this from the Schedule M-1. Line 3 includes nondeducted expenditures like disallowed meals. The instructions there were to subtract cash spent (recurring cash spent if projecting cashflow), otherwise ignore. Since we are projecting cashflow, determine whether the $2,704 fines and penalties are recurring. You can check the second year s return to see if they are there as well. I assumed they were not. The good news, if you cannot determine whether a significant sum is recurring cash spent, subtract it anyway. Then make an entry in your notes. For example: IF MORE QUALIFYING INCOME IS NEEDED, determine if Fines and penalties (M-1, Line 3) is recurring cash spent. If not, do not subtract. Form 1125, Line 5, Other Costs Sometimes this will include insurance as well. If the insurance on the other deductions schedule does not appear sufficient, check here. In the case of the fishery, we find Crewshares here. This is like subcontractors. When I saw no wages to others on the front page or cost of labor on Schedule A, I wondered how the owner did this by himself. Obviously, he did not. Suggested Procedure: As you review each supporting schedule, check it off. When you think you are done with the return, come back and be sure there are checkmarks next to each relevant schedule. PC/V1 Linda Keith CPA, Inc. February 2012

4-26 BEYOND THE 1040 Linda Keith CPA, Inc. February 2012 PC/V1