The document provides a guide to analyzing tax returns for lenders using Lego pieces as an analogy. It describes using green Legos to represent recurring cash flow, blue Legos for non-cash items, and yellow Legos for non-recurring items. It also mentions using red Legos to flag any red flags. The document then describes a six Ns approach to get from taxable income to recurring cash flow using the categories of nontaxed income, nondeducted expenses, noncash expenses, nonrecurring income/expenses, new income/expenses, and nondocumented income.

1. Green Legos Six Ns and A Map to Tax Returns A guide to tax return analysis for bankers.

3. LEGO™ APPROACH To Tax Return Analysis

4. Picture a pile of Legos™, most of them green. Build something with them and you’ll have a model of the tax return.

6. Examples of Recurring Cashflow Wages ◘ Rentals ◘ Capital Gains ◘ Child Support ◘ Business

7. BLUE Legos represent Noncash items Why do we need to find and get rid of blue legos? Noncash items do not impact the borrower’s ability to pay debt.

8. Depreciation Carryovers Net Operating Losses K-1 Pass-throughs Noncash Examples No one wrote a check for these items!

10. Capital Gains? Alimony? Contract Receivable? Insurance Proceeds? Examples of Nonrecurring Income Why question marks? These may or may not be recurring. Check.

12. Red Legos represent Red Flags Why do we need to find and resolve red legos? If the deal does not make sense or the numbers make you nervous, you could be looking at fraudulent statements or a business getting into trouble. Even if you aren’t worried, you need to recognize what will worry the underwriters or loan review. Get those questions resolved and you have a better chance of making the loan. Or if is not a good loan, move on to the next opportunity!

13. Inadequate taxes Settlement Fees Red Flags If something doesn’t look right, pick up the phone and call the borrower.

16. Recurring Cashflow Use the green lego approach. You’ll start with this…

17. Recurring Cashflow And end with this…

18. FOR ANY TAX RETURN 6 Ns From Taxable Income to Cashflow

19. Some bankers just LOVE the Green Lego Idea.

20. Others think I must be NUTS! Well, maybe so….

21. From taxable income to recurring cashflow to pay debt I long ago learned that there is more than one way to explain the same thing. Comes in handy in my tax return analysis training and webclasses. So let’s try the 6 Ns.

22. To get to Historical Cashflow Start with taxable income… Add nontaxed income Subtract nondeducted expenses Add back noncash expenses

23. To get to Recurring Cashflow Start with historical cashflow… Add new income Subtract nonrecurring income or Add back nonrecurring expenses Subtract nondocumented income

25. CANADA TO MEXICO The Road Trip Method

26. Take the direct route. Which one of these pictures looks like you at work?

27. Or is it this one?

28. Imagine you are headed from Vancouver, British Columbia to Tijuana, Mexico and time is short… You won’t visit the Space Needle, then Yosemite National Park, then the Oregon Coast, Fisherman’s Wharf in San Francisco, back up to the home of the Appaloosa Stallions, on to Hollywood and then to Mexico.

29. This is more like it!

30. Start at the top of the return. Work your way down, step by step!

31. When you get to a line that comes from somewhere else, circle it and trace it to the source. In this case, Schedule B.

32. Take the detour to Schedule B and review that schedule for adjustments or questions. I circle the number on page one to show I traced it. Then I circle the total on the supporting schedule to show I checked that it is the same as the number on the front.

33. When you are done with that schedule, put a checkmark to show you are … then back to page one and continue down the main highway.

34. Whenever you get interrupted by a phone call or meeting, draw a line where you are. It will be easy to pick it back up after the interruption.

36. Congratulations You have successfully completed Tax Return Analysis Green Legos, Six Ns and a Map Presented by Linda Keith CPA