Charlie Buker, Author at Bukers Taxanalysis

Section 461(l) Explained: Excess Business Loss Rules for Lenders and Cash Flow Analysis

Charlie Buker — Mon, 30 Mar 2026 18:13:25 +0000

Section 461(l) Explained: Excess Business Loss Rules for Lenders and Cash Flow Analysis

Introduction

Have you ever come across something called a “Section 461(l) excess business loss adjustment” on an individual tax return and wondered what it is? We recently received a call on the Bukers Hotline about this item and whether it should be included in cash flow.

On this week’s cash flow article, let’s explore what a Section 461(l) adjustment is and how it impacts cash flow analysis for lenders.

Facts and Circumstances

On the call, the analyst noted that the borrower had several income-producing activities that were generating negative cash flow. At the same time, there was a significant source of income exceeding $1 million that the analyst noticed on Form 1040, Schedule 1, Line 8p – Section 461(l) excess business loss adjustment.

The analyst’s question to us – can they treat that income as cash flow for the borrower? The analyst added that the inclusion of this income to cash flow would help significantly in getting the loan approved.

What is a Section 461(l) excess business loss adjustment in the first place?

The Section 461(l) excess business loss adjustment is a tax instrument that was introduced with the Tax Cuts and Jobs Act of 2017 and was extended by the OBBB Tax Law update of 2025. Its job is to limit an individual taxpayer’s ability to offset their non-business income (e.g., salaries, interests, dividends, etc.) with various business losses from Schedule C, Schedule E, and Schedule F.

When the limitation was originally introduced, the applicable thresholds began at $250,000 for single taxpayers and $500,000 for taxpayers who are married filing jointly. These thresholds have been indexed for inflation and currently are:

Single – $305,000
Married Filing Jointly – $610,000

This limitation is commonly referred to as the excess business loss limitation under Section 461(l).

Let’s summarize this in plain English

A single or married taxpayer is limited to the amount of business losses from Schedules C, E, and F that they can deduct. Any losses they incur in a single year exceeding the applicable threshold are disallowed for tax purposes and are carried over to future years, similar to net operating losses.

Helpful Example – 461(l) Adjustment in practice

Let’s add a quick example to help illustrate the application of a Section 461(l) loss adjustment.

Say we have a married couple of borrowers named Dan and Jane Loaning. Dan runs the family farm and reports income and loss on Schedule F. Jane runs a coffee shop and reports income and loss on Schedule C.

Since they are married, both business activities are reported on their joint tax return. As it turns out this year, Dan and Jane both had a rough business year.

Here is the breakdown:

$250,000 – Schedule C Loss
$460,000 – Schedule F Loss
Total business loss = $710,000

The excess of their business losses over the applicable threshold is $100,000 ($710,000 – $610,000 =$100,000) which is disallowed for the current year. On the next year’s return, Dan and Jane can carry forward the $100,000 of disallowed losses to offset future taxable income.

On their current year’s income tax return, the $100,000 of disallowed losses will show up on Form 1040, Schedule 1, Line 8p – Section 461(l) excess business loss adjustment. It is presented as a positive number that looks a lot like income at a first glance. However, its role is solely to add back the disallowed losses reported from business activities exceeding the applicable threshold.

The 461(l) loss adjustment is not in any way, shape, or form cash flow to the borrower. It is merely a tax instrument designed to adjust taxable income unfavorably to disallow excess losses from Schedules C, E, or F. If it were counted as a part of cash flow, it would drastically overstate cash flow for the borrower.

It is imperative that Form 1040, Schedule 1, Line 8p, is ignored in arriving at cash available for debt service.

What happens on the following year’s return?

On their following year’s tax return, Dan and Jane Loaning will recognize their 461(l) excess business loss carryforward as if it were a net operating loss. The amount will be reported as an NOL carryforward and directly offset any taxable income.

We must ignore the effects of any NOLs since we accurately account for cash flow in the given year. Any inclusion of the effects of an NOL carryforward will result in double-counted cash flows. Therefore, we can simply ignore the effects of the 461(l) carryforward in the following year.

Key Takeaway for Lenders

A Section 461(l) adjustment is not cash flow. It is a tax limitation that disallows excess business losses and must be excluded from borrower cash flow analysis.

Concluding Thoughts

This question called in to our Bukers Hotline is a great example of how certain items on a tax return can look like income, but they are not true cash flow to the borrower. Paying careful attention to the cash flow nature of these unique items helps inform the lending decision and can protect the financial institution from signing off on a risky loan.

Learn More

Would you like to learn more about complex situations like this? Check out our Bukers Academy today! The online self-study training course for cash flow analysis covers all sorts of complex topics similar to the one explored in this article. Feel free to email us at support@taxanalysis.com or call us at 503-520-1303 for more information!

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Tax-Exempt Interest Income from Pass-Through Entities

Charlie Buker — Mon, 23 Feb 2026 16:47:54 +0000

Tax-Exempt Interest Income from Pass-Through Entitles

Have you ever encountered an unusually large dollar amount on an individual’s tax return that made you stop and think twice? Recently, an analyst had this situation occur and called in to the Buker’s Hotline for assistance. On this month’s cash flow article, let’s explore their scenario and the appropriate cash-flow adjustments required.

Unusual Tax-Exempt Interest Income

The analyst explained that their borrower reported over $500,000 of tax-exempt interest income on line 2a on their Form 1040. Their tax return did not have much other activity, and prior years’ returns did not show similar amounts of tax-exempt interest income. To make things worse, since tax-exempt interest income is not listed on Schedule B, the analyst had no clue where this large potential cash inflow was coming from. The analyst’s perspective was understandable – they felt that the $500,000 of tax-exempt interest income seemed random, as if it came from nowhere. Without the historical support, the analyst felt this potential cash inflow raised some red flags worth investigating.

Support Found on Schedule K-1

To make sense of this situation, we looked to see if there were any supporting statements related to the significant tax-exempt interest income reported on the tax return. Since tax-exempt interest income is not reported on Schedule B, we had to find alternative sources of documentation to learn more. As luck would have it, there was a supporting schedule attached to the end of the return that broke down the total interest income reported by the individual during the year. We were able to see on that schedule that the tax-exempt interest income was actually passing through to the borrower’s return from their Form 1065 Schedule K-1.

The income was earned by the borrower’s partnership and passed through to the individual’s return based on their ownership percentage of the partnership entity. This means that the $500,000 of tax-exempt interest income was pass-through income that was being reported on the individual’s return for tax purposes only. More importantly for our cash flow analysis, that tax-exempt interest income represents “paper income” that we do not include in our borrower’s cash flow figures.

Pass-Through Income/Loss comes in all shapes and sizes!

This unusual example of high tax-exempt interest income is a great reminder that items of pass-through income and loss can come in many different forms. Typically, tax-exempt interest income is related to an individual’s holdings of municipal bonds or other tax-exempt investments. In this case, the borrower had no historical precedent for such a high figure for tax-exempt interest income, so it made sense that this was being passed through by the borrower’s partnership.

We don’t typically think of tax-exempt income being an item that would be passed through by a partnership or S Corporation, but it is certainly possible. The analyst was correct to say that “something felt off” regarding the large tax-exempt interest income. The extra steps we took ensured they did not erroneously overstate the borrower’s cash flow available to service debt.

If you are a Bukers software user and you ever come across a similar situation where you, as the analyst, feel as if something doesn’t quite feel right with the borrower’s tax return, feel free to call the Bukers Hotline. Our team of CPAs is ready and happy to help you with any questions that may arise within the spreading process.

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Capital Gains and Losses: Recurring or Non-recurring?

Charlie Buker — Wed, 07 Jan 2026 18:06:39 +0000

Capital Gains and Losses: Recurring or Nonrecurring?

The other day, an analyst called in to the Bukers Hotline asking about some items that were reported on their individual borrower’s Schedule D. They wanted to know whether their borrower’s capital gain was recurring or non-recurring, and what the associated cash flow adjustments should be. On this week’s cash flow article, let’s review the facts and circumstances, and help the analyst with their cash flow analysis.

Facts and Circumstances

The best way to determine whether capital gains and losses are recurring or non-recurring in nature is to get a detailed understanding of the facts and circumstances surrounding the transaction. The more information that you, as the analyst, can garner, the more successful you will be in this situation.

Our analyst told us that their individual borrower was operating a sole proprietorship whose primary activity was purchasing and developing real estate. The capital gain in question was related to the sale of a truck during the year. The borrower held the truck for several years and sold it for a gain of about $5,000.

Immediately, we already are given a wealth of valuable information that can help us make our decision. Often, capital gains or losses are more likely to recur in future years if they are directly related to a main source of cash flow to the borrower.

In this case, our borrower’s main source of cash flow is their sole proprietorship related to flipping houses, but this is unrelated to the sale of a long-held personal asset, like their truck. With this information, we are already headed down the track of a non-recurring capital gain.

Historical Analysis

At this point in the call on the Bukers Hotline, our CPA asked the analyst if the borrower had any capital gains or losses recognized on the past couple of years’ worth of tax returns. The analyst responded that there were no other capital gains or losses recognized in the two preceding tax return years. This additional context lets us know that our borrower does not have a history of reporting cash inflows related to capital gains. Since they don’t have any historical capital gains, we feel even better about our assertion that this year’s capital gain is likely non-recurring in nature.

Conclusion and more!

Our ultimate recommendation to the analyst is that their borrower’s capital gain for the current tax year, related to the sale of their truck for a $5,000 gain, is likely to be non-recurring in nature. To arrive at this recommendation, we combined the current year’s facts and circumstances with the borrower’s historical performance, both of which contributed to the same conclusion. As a result of this, the appropriate cash flow treatment would be to not include this gain or return of capital in cash flow available to service debt.

Key Takeaway for Lenders:

Determining whether capital gains or losses are recurring requires analyzing both the nature of the transaction and the borrower’s history. Gains unrelated to the borrower’s primary income source and without historical consistency are typically non-recurring.

This situation called in to our Bukers Hotline was a great example of how the recurring nature of capital gains and losses can affect cash flow analysis. Would you like more information about this topic, and beyond? Check out our Bukers Academy Online training course. We walk enrollees step-by-step through the entire analysis related to Schedule D, and everything else under the umbrella of individual tax return analysis. We use hundreds of examples to cement ideas and cover even the most complex topics.

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Medicaid Waiver Payments on Form W-2: What Lenders Should Know

Charlie Buker — Fri, 07 Nov 2025 21:06:10 +0000

Medicaid Waiver Payments on Form W-2: What Lenders Should Know

An analyst recently called into the Bukers Hotline with a unique situation. A borrower, who hadn’t yet filed their 2024 tax return, submitted their 2024 W-2 for cash flow analysis. When spreading the salary information directly off the W-2, the analyst noticed that the amount in Box 1 was significantly lower than what was reported in prior years. The analyst also noticed a large amount in Box 12 with the accompanying code “II”, noting that there was no amount in Box 12 in prior years. The analyst asked us, “What does all of this represent? And what is my true cash flow for the borrower?”

Let’s dig a little deeper to help the analyst on this month’s cash flow article.

Medicaid Waiver Payments

On a borrower’s W-2, if Box 12 contains code “II”, that means that our borrower received Medicaid waiver payments excluded from gross income. Back in 2014, guidance was released by the IRS regarding the federal tax treatment of income earned by caregivers in specific situations. For a caregiver who tends to a sick individual and receives Medicaid waiver payments as compensation for their caregiving, they may be allowed to exclude that income from federal taxation. To qualify for this tax-exempt treatment of the income earned, the caregiver must reside in the same home as the sick individual, along with some other criteria.

So, How Does It Cash Flow?

The cash flow implications of Medicaid waiver payments are relatively straightforward. The income that is tax-exempt and reported in Box 12 with code “II” on the borrower’s W-2 should be added to cash flow. Medicaid waiver payments are a form of income that is exempt from federal taxation, yet still cash earned by the individual and needs to be treated accordingly for cash flow analysis.

What if our borrower had given the analyst their tax return instead of a Form W-2? Well, the taxable portion of W-2 wages would be reported on Form 1040, Line 1a. The nontaxable portion, comprised of these Medicaid waiver payments, could be reported in a couple of areas on our borrower’s tax return. They could be listed on either Form 1040, Line 1d, or they could be reported on Form 1040, Schedule 1, Line 8s. The difference is a preference of the borrower and tax preparer based on whether they want to take the earned income credit or not. This is simply presentational and does not affect cash flow. The analyst would add these amounts representing nontaxable Medicaid waiver payments to cash flow, regardless of where they are reported on Form 1040.

Concluding Takeaways

The main takeaway as an analyst is, if your borrower is a caregiver, be aware that a portion of their income earned from that profession has the potential to be tax-exempt. If their wages reported on Line 1a of Form 1040 decrease drastically from their historical performance, check your borrower’s return for any listing of nontaxable wages from Medicaid waiver payments, either listed on Form 1040 Line 1d or on Schedule 1, Line 8s. These amounts might need to be added to your borrower’s wages to arrive at total cash flow for wages earned.

This is another great example of a situation where it is helpful to have a solid understanding of the facts and circumstances governing your borrower’s day-to-day life. Since our analyst was aware that the borrower worked as a caregiver for their relative, it was easy to deduce why the rule for tax-exempt income in this situation applied. At Bukers, we always recommend that our clients get to know their borrowers, and the ins and outs of their sources of cash inflow and outflow.

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Paid Family Leave – How is it Reported on a Tax Return?

Charlie Buker — Thu, 04 Sep 2025 08:44:03 +0000

Paid Family Leave

How is it Reported on a Tax Return?

An analyst reached out to us recently on the Bukers Hotline with a question about the Family and Medical Leave Act (FMLA) and how it may affect their borrower’s cash flow. The borrower told the analyst that their W-2 wages were going to appear lower than expected on Page 1 of their tax return, but in reality, their salary remained consistent to historical performance. The analyst asked us, “how could this be possible?” Let’s help them out on this week’s cash flow article.

Paid Family Leave - State Intervention

Did you know that more and more states are starting to adopt policies that mandate paid family leave for employees? Let’s back up for a second. The federal law for family and medical leave (under the FMLA) is that employers must allow employees up to 12 weeks of unpaid leave per year to allow for bonding time with newborns or being a caregiver for a family member with a serious medical issue. This law mandates companies to continue these individuals’ health insurance policies and ensures that their positions will remain unfilled during this time.

Certain states have intervened and added another clause to this federal policy which also mandates that employees continue to receive salaries, or at least a portion thereof, during this family leave period. These are considered “Mandatory Participation” states, including Washington, New York, California, Oregon, and others. For states with mandatory paid family leave, employees and employers have a portion of their wages withheld each pay period that goes towards funding this state program. When employees take their family leave, they continue to earn a salary, except it is paid by the state rather than the employer.

So how does it cash flow? What adjustments should we make?

Well, in short, this continues to cash flow the same as it normally would. The borrower still receives their entire salary, it just comes from two different sources – the state government pays them for up to 12 weeks of the year, and their employer pays them for the rest of the year. For cash flow analysis, we simply need to know where to look in our borrower’s documentation to substantiate the flow of cash to the individual. The portion of salary paid by their employer will continue to be reported in Box 1 of the borrower’s W-2, which will then flow to Line 1a on Form 1040. Nothing new so far.

The portion of salary paid to the borrower from the government (pursuant to the state’s rules on FMLA) may be reported on a Form 1099-G issued to the borrower. From there, it will likely flow to Form 1040, Schedule 1, Line 7 – Unemployment compensation. State rules vary, so you may alternatively see this amount reported on Schedule 1, Line 8 – Other income. For cash flow purposes, we can consider that amount to be a component of salaries and wages and ensure that it is added to our borrower’s cash flow.

Voluntary Participation States

There are a handful of other states that have adopted similar policies designed to ensure that employees continue to earn their wages during family leave, however it is paid from a participating insurance company rather than the state itself. These are considered “Voluntary Participation” states and include Tennessee, Texas, and Florida, amongst others.

The cash flow implications for these states would be similar to mandatory participant states, except the family leave portion of wages is coming from the insurance company rather than the state government. Because of this, the borrower will not receive a Form 1099-G. Be on the lookout for alternative forms of documentation, such as a Form 1099 or equivalent, issued by the private insurer to the borrower.

Best Practices

So, what are our key takeaways? First off, as an analyst, ensure that you are taking into account all of the facts and circumstances of a borrower’s day-to-day life. If they recently had a child, take a minute to consider that they may have received state benefits via paid family leave. If their W-2 wages for the year seem lower than historical average, you may want to ask them if they received a Form 1099-G, and you can also keep a lookout for unemployment compensation to be reported on Schedule 1 of Form 1040. In some cases, your borrower may not know to give you a heads up of the paid family leave, so understanding the different ways income flows to a borrower’s tax return is crucial in arriving at the most accurate cash flow figure.

If your institution uses the Bukers software and you ever come across a difficult tax return spreading dilemma, feel free to call the Bukers Hotline at 503-520-1303. Our team of CPAs is standing by and ready to help work through any tax return question you may have while performing cash flow analysis.

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GILTI as Charged: How to Cash Flow Global Intangible Low-Tax Income

Charlie Buker — Thu, 17 Jul 2025 23:16:18 +0000

GILTI as Charged

How to Cash Flow Global Intangible Low-Tax Income

We recently received a call on the Bukers Hotline from an analyst who was spreading a prospective borrower’s individual tax return and noticed some unusual sources of income. The analyst told us that they received Form 8992 and Form 5471 along with the tax return package submitted by the borrower. Their question to us was – what is this income and how does it affect my borrower’s cash flow? In this week’s cash flow article, we are going to investigate the cash flow implications of GILTI (Global Intangible Low-Taxed Income).

What is GILTI (Global Intangible Low-Taxed Income)?

GILTI is a relatively new tax concept that was added as a component of the 2017 Tax Cuts and Jobs Act (TCJA). The tax law addition requires individuals with a 10% or greater share in certain foreign companies (referred to as “CFCs” – Controlled Foreign Corporations) to pay US tax on income derived from certain types of intangible assets held by the CFCs. The term “GILTI” is used to describe the type of foreign intangible income upon which this new tax is imposed. Individuals will report their GILTI on Form 8992 and they would also file Form 5471 to register their ownership with the CFC to the IRS.

How does GILTI Cash Flow?

The analyst who brought this question to the Bukers Hotline asked us during our conversation, “Do I need to make any adjustments to include the income reported on Form 8992 to cash flow?”. Our direct answer to them was, “No,” but let’s explain why.

For all intents and purposes, we can treat income reported on Form 8992 as if it were being reported on Page 2 of Schedule E and therefore ignore it from cash flow. Like the reporting of flow-through income/(loss) reported on Page 2 of Schedule E, the income reported on Form 8992 is simply for tax purposes and does not reflect any true cash flow received from the CFC. It is merely reported on Form 8992 so that it can then flow to Schedule 1 of Form 1040 and be included in the borrower’s AGI, so they then must pay tax on the income. This is another good example of why we never begin our cash flow analysis using AGI as a starting point. Any cash flow implications to our borrower with respect to the CFC would likely be presented as distributions on a Schedule K-1 received or as dividends listed on our borrower’s Schedule B.

This was a great question from our analyst, and it helps illustrate the importance of keeping current with new tax acts as they arise. As tax legislation is passed by new administrations, tax return packages may be directly affected. At Bukers, our team of CPAs updates our products annually to ensure that we account for all cash flow implications of new tax laws and legislation, so that you don’t have to. Stay posted to our Bukers newsletters going forward as we will continue to cover tax law changes and their effects on cash flow analysis.

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Partnership Distributions to a Trust: How Does it Cash Flow?

Charlie Buker — Tue, 10 Jun 2025 08:10:50 +0000

Partnership Distributions to a Trust

How Does It Cash Flow?

We recently received a call on the Bukers Hotline from an analyst who was spreading a business return of a partnership entity that was owned by a married couple. The analyst was reviewing the Schedule K-1s issued from the partnership to the two individuals and noticed that the recipient was listed as “Jane Doe Trust” rather than simply “Jane Doe” (same for her husband, John Doe). The analyst asked us if they could treat the distributions from the partnership to the partner’s trust as cash flow to the individual. In this month’s cash flow article, let’s determine the best way to help the analyst.

Background - How can a Trust be a Partner of a Partnership?

Did you know that non-individuals can be partners in a partnership? Typically, partners of a partnership are individuals, but other types of entities can qualify as a partner in a partnership. These other entities include, but are not limited to corporations, other partnerships, estates, and trusts. This wide array of qualifying partners is one of the main differences between a partnership and an S corporation. Shareholders of an S corporation are limited to individuals, estates, and a handful of trusts. Because of this key difference, it is more common to see non-individuals acting as partners of a partnership than it would be to see non-individuals acting as shareholders of an S corporation.

Relevant Factors to Consider for Trusts

Back to the question at hand, can the analyst consider cash distributed to the Jane Doe Trust to be cash flow to Jane Doe? As many times is the case with complex tax issues, the answer is – it depends on the facts and circumstances.

The first relevant factor for the analyst to consider is the control of the assets. Typically, when the partnership distributes cash to the Jane Doe Trust, the cash is held in the trust and is not immediately in the hands or control of Jane Doe. The trust, regardless of its name, is usually its own separate, legal entity from the individual. If the individual wanted to receive that cash, the trust would likely have to make another distribution to the individual. In theory, this can be facilitated with ease, but there are other relevant factors to now consider.

What kind of restrictions are held against the trust from distributing the cash to the individual? Are there other parties who are also beneficiaries of the trust who have the right to the cash held in the trust? Who is the fiduciary of the trust? Are there any conditions that must be met for cash to be distributed? If the analyst is thinking any of these questions to themselves, they are already on the right track. The answers to their questions can likely be found in the second relevant factor our analyst should consider – the trust agreement.

Every trust has an agreement that stipulates things like distribution of assets, restriction of assets, processes in place to distribute assets fairly among beneficiaries, and so on. If the analyst could receive a copy of the trust agreement, it would likely shed quite a bit of light on the situation at hand and would answer a great number of our questions. If the analyst is unable to receive the trust agreement, they can contact the borrower, the borrower’s accountant, or the fiduciary of the trust and ask probing questions (like the ones posed above) to determine the relevant factors of the situation.

Important Caveat - Living Revocable Trusts

An important caveat to this topic needs to be made regarding living revocable trusts, which are often set up in a way to ease the facilitation of assets directly to a particular individual. Living revocable trusts can be created so that the same person who creates the trust (the grantor) is the same person who has control over deciding how assets are distributed (the fiduciary), and they are also the same person who receives those distributions (the beneficiary).

These specific trusts are often created to avoid the trust assets going through probate after the death of an individual. While the individual is still living, however, the trust assets can be considered directly under that individual’s control, since the living revocable trust is a disregarded entity for tax purposes. It is still important in these situations to analyze all facts and circumstances to ensure that there are no other fiduciaries or beneficiaries who may disrupt the flow of assets to the individual who set up the trust.

Varying Trust Structures - Example

The analyst’s main goal should be determining the individual’s access to trust assets and their overall ease of receiving cash held by the trust. Remember, cash held by the trust is not necessarily cash held by the individual, but the varying answers to the relevant factors considered above can affect the way we view the individual’s access to cash.

For example, consider two varying trust structures. The first is a trust solely held by the individual and their spouse, and there are no restrictions in the trust agreement that affect the individual’s access to cash. The second structure is a trust held by the individual and their five siblings, each with equal share of assets held in the trust, and each with specific voting rights that decide when distributions are made. Comparing the two situations, the first situation suggests the individual has greater access and ability to withdraw cash from the trust, while the second scenario provides barriers to distribution and a lower distributive share of the same cash held in the trust.

Conclusion

This question is a great example of how the facts and circumstances of a given case can completely change the answer we may provide. For this reason, it is important for analysts to have a good foundational understanding of pass-through entities like trusts.

For more information on complex topics like this, check out Bukers Academy. Our self-paced, online training platform teaches the ins and outs of cash flow analysis and explores tons of complex topics similar to the content discussed above. For more information, visit our website or email learning@taxanalysis.com.

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Debunking Form 1041 – Distribution Distractors

Charlie Buker — Thu, 22 May 2025 07:26:37 +0000

Debunking Form 1041 - Distribution Distractors

We recently received a call on the Bukers Hotline from an analyst working on spreading a trust with a Form 1041. The analyst noticed a few different line items on the first two pages of Form 1041 that appeared to resemble distributions made from the trust entity. We helped show that these line items were distractors and can’t always be relied on to determine trust distributions. Let’s investigate those further for this month’s cash flow tip!

Distribution Distractors

Page 1, Line 18

As we went through the spread of Form 1041, there were a few line items that jumped off the page to the analyst. First, the analyst noted the Income Distribution Deduction on Page 1, Line 18, and they asked if that corresponding amount was the total distributions issued by the trust. We explained that it was just a tax deduction being taken by the entity pursuant to a calculation on Schedule B of Form 1041.

While it is possible that this line item reflects true cash distributions issued by the trust, there are a number of non-cash components and limitations included in the calculation of the Income Distribution Deduction that muddy the waters from a cash-flow perspective. For this reason, we cannot simply refer to Page 1, Line 18 as distributions on Form 1041.

Schedule B, Line 9

We navigated over to Schedule B of Form 1041 to show the analyst how the Income Distribution Deduction was being calculated and explain why it’s not reliable to consider that equal to the distributions issued by the trust. Upon investigating Form 1041 Schedule B, the analyst asked “Well, what about Line 9, ‘Income required to be distributed currently’? Surely income required to be distributed must be the trust’s distributions, no?”

While we can see why the analyst says that, the IRS’ instructions allow for greater variability of this line item than one might assume. The IRS form instructions stipulate that Schedule B, Line 9 represents the income required to be distributed, whether it is distributed or not.

Furthermore, the determination of what income is required to be distributed relies on the underlying trust agreement and applicable local laws. This adds multiple layers of uncertainty as to whether this amount was even distributed in the first place.

Trust agreements are customizable in nature and are not uniform from one to the other. The same can be said for local laws, which completely vary throughout the country. This leaves analysts without a clear indicator of distributions paid by a trust entity on Form 1041.

Resolution for Trust Distributions

While Form 1041 is unreliable regarding distributions made by a trust, there are always alternatives to be explored for determining cash flow. The most accurate way to determine how much cash distributions were made by a trust is to consult with your borrower. Additionally, an analyst can receive confirmation about distribution amounts from the executor of the trust, as their duties require them to sign off on distributions made to trustees.

Want Detail on Complex Topics Like This?

We love getting calls with complex questions like this on our Bukers Hotline. If you are interested in learning about other complex topics, check out our Bukers Academy Online training. Our course curriculum explores all components of personal cash flow analysis, including several advanced topics like NOLs, capital losses, and Section 179 deductions. If you would like more information on enrolling in the Bukers Academy Online, please email us at bukers.academy@taxanalysis.com or give us a call at (503) 520-1303.

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Section 465d Carryover – Cash Flow Impacts

Charlie Buker — Mon, 21 Apr 2025 22:40:39 +0000

Section 465(d) Carryover - Cash Flow Impacts

We recently received a call on the Bukers Hotline from an analyst who was spreading a Schedule C for a sole proprietorship. The analyst noticed an item of Other Expense listed in Part V titled “Section 465(d) carryover.” Their question to us was: What is this item of expense and how does it affect cash flow?

At-Risk Basis Explained

For starters, Section 465 of the tax code addresses the “at-risk” rules and limitations imposed on individuals conducting business activities through sole proprietorships, partnerships, and S Corporations. Essentially, the at-risk limitation for the individual equals the amount of money that they invested in the company plus their share of the company’s liabilities. In other words, their at-risk basis is the monetary extent to which they are “on the hook.” Their at-risk basis is further increased by additional cash or property contributions, their share of net income, and the value of additional liabilities assumed. Their at-risk basis can be decreased by their share of net losses deducted in a year and by any distributions received.

Section 465(d) Carryover and Cash-Flow Implications

For tax purposes, an owner of a sole proprietorship can only deduct losses up to the amount of at-risk basis they have in the current year. Any losses incurred in a year that exceed the owner’s at-risk basis cannot be deducted. These excess losses are disallowed and are carried forward to future years, as is permitted under Section 465(d). Hence, these disallowed losses due to at-risk limitations garner the name – Section 465(d) carryover.

But how can we use this information to help answer our analyst’s question? What do we do when we encounter a Section 465(d) carryover as an expense item on Schedule C? Let’s look at an example scenario to guide our analysis.

Example Scenario

Mark owns ABC Company, a sole proprietorship, and his at-risk basis in the company is $50,000. In Year 1, Mark’s company doesn’t perform well and incurs a $75,000 loss on its Schedule C. He is only able to deduct $50,000 on his tax return, which is equal to his at-risk basis, meaning the remaining $25,000 of losses are disallowed and carried forward under IRC Section 465(d). Since Mark takes a $50,000 deduction, his at-risk basis is reduced to zero. For cash flow purposes, we are still going to count the entire $75,000 as a cash outflow for Mark (assuming no other cash flow adjustments are required) even though he is only able to deduct $50,000 for tax purposes.

In Year 2, Mark contributed $40,000 of cash to his company which increased his at-risk basis accordingly. ABC Company has stabilized since its disappointing first year. As a credit analyst, you notice an item of Other Expense listed on Part V of Schedule C called “Section 465(d) Carryover” for $25,000. Since Mark’s at-risk basis in the sole proprietorship increased and he didn’t incur large losses in Year 2, the company is able to carry forward the disallowed loss from Year 1 and receive a tax deduction in Year 2 accordingly.

Rather than include the Section 465(d) carryover as a cash outflow in Year 2, we correctly add it back to cash flow after first deducting total expenses from Schedule C. Since we considered the entire $75,000 loss in Year 1 to be a cash outflow for the sole proprietorship, we cannot classify the 465(d) carryover in Year 2 as a cash outflow because that would result in double-counting the $25,000 disallowed expense. For cash flow purposes, we typically add back Section 465(d) carryovers because we accurately account for excess expenses in the year of disallowance.

Want Detail on Topics Like This?

If you are interested in learning about other complex topics, check out our Bukers Academy Online training. Our course curriculum explores all components of personal cash flow analysis, including several advanced topics like capital loss carryovers, bonus depreciation, and Section 179 deductions. If you would like more information on enrolling in the Bukers Academy Online, please email us at bukers.academy@taxanalysis.com or give us a call at (503) 520-1303.

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Schedule E Pass-Through Activity: Common Pitfalls for Lenders

Charlie Buker — Tue, 25 Mar 2025 21:30:21 +0000

Schedule E Pass-Through Activity: Common Pitfalls for Lenders

Last month, we discussed how to avoid pitfalls on Schedule E related to passive activity losses. We are going to look at the same analyst’s question, but this time we will emphasize the potential pitfalls related to income or loss from pass-through entities. Let’s start by reviewing the details of the analyst’s question.

We received a call on the Bukers Hotline where a new analyst was trying to spread cash flow from Schedule E, which breaks out income and losses from rental and royalty activities, as well as partnerships, S corporations, and other pass-through entities. The analyst’s first inclination was to use the amount listed on Form 1040, Schedule 1, Line 5 as the cash flow from Schedule E. We told the analyst that there are multiple reasons why that number could be distorted and is not an accurate representation of Schedule E cash flow.

Why Pass-Through Income/(Loss) is Not Cash Flow

Page 2 of Schedule E is where you will find the income or loss from partnerships, S corporations, and other pass-through entities like estates and trusts. For an unwary analyst, it would be easy to examine Page 2 of Schedule E and notice several items of income that they might want to include as sources of cash flow. But what are the real sources of cash flow as listed on Page 2 of Schedule E? The answer is – None! The pass-through income or loss reported on Page 2 of Schedule E is simply “paper” income that represents the borrower’s individual share of income or loss earned by the pass-through entity.

For partnerships and S corporations, these items of income or loss listed on Schedule E flow in directly from the borrower’s Schedule K-1 and they do not represent real cash received by the borrower. To figure out our true cash flow to the borrower from pass-through entities, we need to analyze their Schedule K-1 for any recurring distributions or guaranteed payments received. We also need to consider any recurring contributions made to the pass-through entity by the borrower, as these would decrease our cash flow to the borrower.

Let’s look back at the call we received on the Bukers Hotline regarding Schedule E income. The issue with using the amount on Schedule 1, Line 5, is that it includes the aggregation of all pass-through income as listed on Page 2 of Schedule E, which we now know is simply “paper” pass-through income and does not represent real cash received by the borrower. If we want to figure out cash flow to the borrower from pass-through entities, we know that we need to examine the Schedule K-1s received.

Want More Detail on This?

The Bukers Academy Online training explores this topic in greater detail in its analysis of Schedule E cash flow. There are additional examples that go into greater depth on this topic and even more from Schedule E. If you would like more information on enrolling in the Bukers Academy Online, please email us at bukers.academy@taxanalysis.com or give us a call at (503) 520-1303.

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