Fred's question:
Can losses from a C Corp or an S Corp be disregarded if the retained earnings account has a positive balance? For example, normally a loss from a C Corp is used as a reduction in the qualifying income of an individual. However, if the C Corp still shows a positive balance even after the reported loss, can the loss be disregarded?
Linda Says:
If you are lending to the corporation (C or S) the purpose of considering the loss, adjusted for five of the "Six Ns" (non cash, nonrecurring, non taxed, non deducted, new) is to determine your best guess as to whether the company can afford the debt they have plus the additional debt they are requesting. We compare the result, Cashflow Available to Pay Debt, to the annual debt payments to determine Debt Coverage Ratio. Debt does not get paid from "taxable income", it gets paid from cashflow.
If you are lending to the owner of the C or S Corp, it likely depends on their % ownership. If low (typically less than 20% or 25%) you may solely be interested in what they actually take home from the corporation, as evidenced by wages and, if an S Corp, distributions. If higher, you may want to determine their share of cashflow available from the C or S Corp because if the company has a deficit in cashflow, you may not want to count on the payments to the owner continuing.
Finally, if you are lending to another business, and this C or S Corp is also owned by the person guaranteeing your loan, and you are doing a global analysis combining owners and the company, your guidelines need to tell you whether to use the owner's actual cashflow in their personal cash-flow calculation (wages and distributions) or a % of the C or S Corp cashflow. The question is which provides you the best estimate of the future cashflow of the owner.
Notice in none of those scenarios do I use the taxable income until I have adjusted it to a cashflow figure. Cashflow pays the bills, not taxable income or a positive balance in retained earnings.
The post Corporate Losses and Cashflow – what’s the impact? appeared first on Linda Keith CPA.