Does the Bukers Taxanalysis System Account for the Standard Deduction?
An analyst recently called in to the Bukers Hotline asking us, “where should I make the adjustment for the standard deduction in your system?” On this week’s newsletter, we will explore how the standard deduction is treated in the Bukers system for tax return analysis. This is a question that we often receive, and it is a great topic to illustrate our renowned reconstructive approach for cash flow analysis.
What does the Analyst Mean?
Within the conversation, the analyst explained that they were accustomed to a different process for tax return analysis, which uses taxable income as a starting point from which adjustments are made to arrive at a borrower’s personal cash flow. One of those adjustments was to add back the standard deduction because it is a non-cash expense in the calculation of taxable income. The analyst expected to see this adjustment, but since we do not even consider this adjustment within our approach for cash flow analysis, they were confused upon its omission.
Reconstructive Approach to Personal Cash Flow Analysis
There is no reason to make these types of adjustments in calculating personal cash flow using our system because we do not use an artificial subtotal, like taxable income or AGI from the Form 1040, as a starting point. Instead, we reconstruct the borrower’s cash flow, one piece at a time, only considering items that are cash inflows and outflows to the borrower. We call this method the reconstructive approach to cash flow analysis.
One of the many reasons we do not begin our analysis using taxable income is because if we did, there would be so many adjustments required to arrive at the borrower’s true cash flow, that we would be almost guaranteed to misstate it. These adjustments include “paper” pass-through income/(loss), various loss limitations, non-cash expenses (like the standard deduction), and many more. Unless the analyst makes every single necessary adjustment, there is a significant risk to overstate the borrower’s cash flow available to service debt.
A second reason is that taxable income and/or AGI from the Form 1040 have absolutely no correlation to a borrower’s actual cash flow. Cash flow could be greater than AGI, it could be the same as AGI, or it could be less than AGI – and this all depends on a borrower’s specific set of facts and circumstances.
We find that the reconstructive approach is more methodical and efficient than alternate systems and provides a more uniform approach within a team of analysts. No matter which analyst on your team spreads a borrower’s tax return using the Bukers Taxanalysis system, the result will always be the same. Our reconstructive approach has been used for over 40 years by lending institutions around the country because of its reliability, uniformity, and intuitive nature.
KEY TAKEAWAY FOR LENDERS
By reconstructing a borrower’s actual cash inflows and outflows rather than starting with taxable income or AGI, lenders can avoid unnecessary adjustments—such as adding back the standard deduction—and arrive at a more consistent and reliable measure of cash flow available to service debt.
Conclusion
If you are a user of the Bukers software or training products, you have access to our team of CPAs available on the Bukers Hotline. Our team is available to assist with any questions that may arise while using our products. If you would like to find out more about the ways that our methodology for tax return analysis can help you and your team, give us a call today at 503-520-1303.