IRS Form 1040 Cash Flow Analysis

Within the United States, a substantial portion of consumer lending credit analysis, and a substantial portion of commercial credit analysis, is based on the review of the Internal Revenue System (IRS) Form 1040 individual tax returns. In addition, financial institution federal regulators are also in support of the usage of the IRS forms as s source of verifiable income for credit analysis purposes.

An individual, who is a U.S. citizen or a Resident Alien, must file a federal income tax return if their gross income is above a certain level; which varies depending on their filing status, age and the type of income they receive. The amount of gross income is revised on an annual basis.

IRS Form 1040,-U.S.-Individual-Income-Tax-Return

W2 Form

Form W-2, Wage and Tax Statement, is used to report wages paid to employees and the taxes withheld from them.

W2 income, which is the most common form of taxable compensation, is reported on IRS Form 1040, line 7: Wages, salaries, tips, etc. Gross income means all income the individual received in the form of money, goods, property, and services earned during the calendar or tax year that is not exempt from tax.
  • Wages, salaries, stipends, commissions, bonuses, and other cash compensation (including prizes or awards).
  • Non-cash fringe benefits.
  • Executive life insurance
  • Imputed income
  • Non-qualified moving expenses
  • Taxable employee business expense reimbursements

  • What is usually considered income (includes but is not limited to):
  • Alimony received
  • Awards
  • Bonuses
  • Capital gains
  • Casualty loss reimbursement in excess of loss of property
  • Child support payments
  • Commissions
  • Deferred compensation
  • Director's fees
  • Disability income
  • Dividends
  • Employee business expenses, cash allowance or reimbursement
  • Estates or trusts income or loss
  • Gambling winnings and losses / Lottery
  • Gifts (in excess of a specific amount)
  • Interest (bank and money market accounts, specific types of bonds); Form 1099-INT
  • Life insurance (cash in amount in excess of premiums)
  • Long-term disability payments received
  • Moving expenses reimbursement:
  • Partnership income or loss
  • Private pensions or qualified annuity plans (with limitations)
  • Public pensions (with limitations)
  • Rents and royalties
  • S corporation distribution
  • Scholarships or grants received and used for nonqualified expenses
  • Severance pay
  • Sick pay
  • Stipends
  • Strike pay
  • Supplemental unemployment benefits
  • Unemployment compensation
  • Vacation allowance
  • Wages, salaries, tips

  • Form 1040

    What is the applicant's filing status? If married, then you must determine whether to include or exclude the spouse's income in the credit analysis.

    Form 1040, Line 7 - Wages, Salaries, Tips

    You can onlly use the W2 income of the applicant who will guarantee / sign the loan. If the spouse is not going to be on the loan then you must determine that individual's share of the total W2 amount on Line 7 and deduct it.

    A copy of the W2 maust accompany the tax form when filed the financial institution doesn't always get a copy for the applicant.

    An owner of a company can also pay themself W2 wages.

    The gross amount of W2 wages can be reduced by the amount the applicant, as an employee of a company, contributed to the employer-sponsored 401(k) or 403(b) retiremant plan. These contributions are included in wages subject to payroll taxes, but (except for contributions to Roth plans) are excluded from taxable income.

    Form 1040, Lines 8a and 8b - Taxable and Tax-Exempt Interest Income

    This is usually interest income from a financial institution where the applicant does their personal banking or has deposits. Thus, it is usually recurring and may be used as income. If the applicant must liquidate deposits in order to complete a purchase transaction, then the annual interest income in the future will be reduced. Thus, the amount from Line 8a may have to be reduced as part of the cash flow analysis.

    If the interest income is not from an FDIC-insured account then the credit analyst must consider the safety of the investment.

    Form 1040, Lines 9a and 9b - Ordinary and Qualified Dividends

    This is usually dividend income from individual stock investments or non-retirement account mutual fund investments held with an investment adviser / custodian. Thus, it is usually recurring and may be used as income. If the applicant must liquidate investments in order to complete a purchase transaction, then the annual dividend income in the future will be reduced. Thus, the amount from Line 9a may have to be reduced as part of the cash flow analysis.

    Form 1040, Line 10 - State & Local Tax Refund

    Do not use this as an income source. A tax filer only receives a state tax overpayment refund if they itemize their deductions, filed a Schedule A, and did not take the Standard Deduction option on the previous year's tax returns. Thus, it is not income, it may not be recurring if the tax filer now decides to take the Standard Deduction, and the amount was already included in the gorss W2 wages on the previous year's tax return.

    Form 1040, Line 12 - Business income or (Loss)

    See   Schedule C

    The net income / or net loss from the Schedule C business activity is usually added to an individual's cash flow analysis.

    Form 1040, Line 13 - Capital Gain or Loss

    Taxpayers must report all sales of capital assets on Form(s) 8949 and Schedule D, even if a Form 1099-B is not received. The taxpayer must also determine if an assetís holding period is long-term or short-term.

    A taxpayer cannot take net losses of more than $3,000.00 per tax year.

    Some persons have capital gain / loss income on an annual basis. For instance, someone who owns a substantial investment in equities and securities, or someone who owns a substantial number of investment real estate properties. The key to including this income in an individual's cash flow analysis is if it is recurring. If it has been received over the past three years, and the applicant's investment or asset management appears to be continuing, then it may be added to an individual's income.

    Form 1040, Line 17 - Rental real estate, royalties, partnerships, S corporations, trusts, etc.

    See   Schedule E

    The form has 2 pages and two primary parts that most credit analysts have to deal with at some point: Part I Income or Loss From Rental Real Estate and Royalties, and Part II Income or Loss From Partnerships and S Corporations.

    Form 1040, Line 61 - Total tax

    This represents the tax due to the Department of Treasury based on the applicant's income less any credits or the addition of any other taxes. This amount is deducted from the applicant's individual cash flow analysis as they have been given credit for gross wages and other sources of income.