-BEYQN^AfiftL

Ability to Pay
Guidance

Prepared for:

• s

U.S. Environmental Protection Agency
Office of Waste Programs Enforcement
401 M Street SW

Washington, D.C. 10460

Prepared by:

-A

Industrial Economics, Incorporated

2067 Massachusetts Avenue
Cambridge, Massachusetts 02140

28 February 1993

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Beyond Abel:
Ability to Pay
Guidance

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TABLE OF CONTENTS

INTRODUCTION 		CHAPTER 1

ASSESSING THE FINANCIAL CONDITION OF A VIOLATOR 			CHAPTER 2

SUBCHAPTER C CORPORATIONS 		CHAPTER 3

SUBCHAPTER S CORPORATIONS 		CHAPTER 4

PARTNERSHIPS 		CHAPTER 5

SOLE PROPRIETORSHIPS 		CHAPTER 6

INDIVIDUALS 		CHAPTER 7

APPENDIX A: GLOSSARY 	A-l

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INTRODUCTION

CHAPTER 1

BACKGROUND

This manual is intended to provide guidance to U.S. Environmental Protection Agency
enforcement staff on determining the ability of a violator to pay a penalty or environmental
compliance costs. In particular, this guidance will help staff "go beyond ABEL" and assess ability
to pay in those cases where the ABEL model produces a negative or ambiguous result.1 Although
ABEL is a useful screening tool, it is designed to be conservative. When an ABEL run produces
a positive result, staff can be certain that the entity is able to pay. A negative or ambiguous result,
however, does not necessarily indicate that the entity is unable to pay. ABEL may produce a
negative result when, in fact, funds are available. This outcome may occur for several reasons:

(1)	The violator might be able to produce a larger cash flow than that predicted
by ABEL. ABEL bases its forecast on historical data from Federal tax
returns. If the violator can pare its expenses, it can generate a larger cash
flow.

(2)	The violator might have assets that are not necessary to its business. These
assets could be sold, generating funds for a penalty or pollution control costs.
ABEL's analysis does not assess a company's assets.

(3)	The violator might be able to assume more debt, or refinance debt that is
owed to affiliated parties. ABEL's focus on cash flow does not directly
evaluate a company's debt capacity.

This manual gives step-by-step instructions on how to investigate these issues. The manual
contains worksheets to guide the user's analyses and draw attention to key information in the
violator's tax returns and/or financial statements. Please note, however, that this approach will
not produce a definitive ability to pay assessment, nor can any methodology. A final ability to pay

1 ABEL is a computer model designed to assist enforcement staff in determining a violator's ability
to pay a penalty and/or environmental cleanup costs. ABEL's assessments are based on financial data
from the violator's tax returns.

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assessment will require the user's judgment about the entity's financial capability and the degree of (
hardship that should be imposed on the violator. Such judgments are by their nature subjective, and
will most likely be reached through discussion within the litigation team and enforcement staff.

Finally, bear in mind that the approach outlined here may not be sufficient for all entities.
Cases involving entities with complex financial situations may require advice from a financial expert.
Throughout the manual, we highlight those situations that could require this type of assistance.

Type nf Rnrity

/

This manual focuses on analysis of private for-profit entities.2 Separate worksheets and
instructions are enclosed for:

•	Subchapter C Corporations,

•	Subchapter S Corporations,

•	Partnerships,

•	Sole Proprietorships, and

•	Individuals.

Federal tax policy is different for each of the entities noted above, and each must submit
different tax forms. The extent to which individual owners may be responsible for the liabilities of
their businesses also varies among these entities. For example, sole proprietors and partners are
personally liable for their businesses. Thus, in a bankruptcy case, creditors could pursue a sole
proprietor's personal assets in order to clear the company's debts. Corporate shareholders, in
contrast, are rarely held personally responsible for the company's liabilities.3 The liability of
individual shareholders in a closely-held Subchapter S Corporation, though, must often be
determined on a case-by-case basis.

: For-profit entities can generally be designated as either "private" or "public." Public for-profit
entities are those whose equity (shares of stock) are traded in some form of open market (usually on one
of the various Exchanges; e.g., NYSE, NASDAQ, and so forth). The equity of private for-profit entities,
in contrast, is not traded publicly but is, rather, held by a group of individual investors (some of which
may be institutions) who control the company.

3 A corporation sets up a legal "veil" that shields its owners from personal liability. Hence the phrase
"piercing the corporate veil" which is used when owners are found personally liable for a corporation's
transgressions.

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For each type of entity, the ability to pay assessment process detailed in this manual will help
staff review ownership and operating affiliations, assets and liabilities, and expenses. Our goal in
this review will be to determine if additional funds may be available. We will use examples
throughout the manual to demonstrate how entities can arrange or use their resources so as to give
the appearance of limited financial resources.

Hnw This Manual is Organi7^

Chapter 2 of this manual outlines the ability to pay evaluation process, from information
collection through final assessment, and discusses the analysis in detail. Chapters 3, 4, 5, and 6
review the analyses for Subchapter C Corporations, Subchapter S Corporations, Partnerships, and
Sole Proprietorships, respectively. In Chapter 7 we discuss financial analysis of individuals, and the
cases in which reviewing an individual's financial position (in addition to that of the business entity)
may be appropriate. Appendix A contains a glossary of important accounting and finance terms and
concepts.

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ASSESSING THE FINANCIAL CONDITION OF A VIOLATOR

CHAPTER 2

GOALS

The primary goal of this guidance is to enable EPA regional staff to further analyze and
make assessments about the ability of environmental violators to pay, penalties. In undertaking this
project, the Agency is aiming to provide a consistent and theoretically sound method for going
beyond the ABEL result. Such consistency will increase the coherence and integrity of ability to pay
analyses across EPA regions. It will also give enforcement staff a better understanding of private
finance and accounting principles, and allow them to review cases more critically.

Another goal of this guidance is to provide a straightforward and relatively simply mechanism
for reviewing an entity's financial position. The worksheets used in the analysis will help staff review
financial information more quickly and will yield a clear and concise record of each case.

The basic investigation framework is similar across the entities we discuss here; however,
there are some differences in the depth of the analysis and the financial information required for
each. To accommodate these differences, we have written a separate chapter for each type of entity.
The following segments of this manual are "stand alone" chapters. Each chapter contains
instructions for researching a specific type of entity and completing the related worksheets.

FINANCIAL INFORMATION

Before conducting an in-depth investigation of an entity, staff must gather important financial
information on the entity being analyzed. The amount of information available will likely depend
on the type of entity (e.g., corporation, partnership, sole proprietorship) and its, size. However, in
all instances enforcement staff should obtain the following:

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Federal Income Tax returns from the past three years (these should already
be available if an ABEL analysis has been conducted).1 These returns are
the primary source of financial information on the violator. Be certain that
the returns are signed, and include §11 supporting schedules (these will be
detailed in the entity-specific chapters). The worksheet-based analysis will
be based on the most recent tax return available; however, you should also
review past returns to see if the company's financial position has changed
significantly over the past couple of years.

Financial Statements from the past three to five years. Although tax returns
axe our primary source of financial information, financial statements are also
helpful in that they provide some information generally not included in the
tax returns. In particular, notes to the financial statements often contain
important information on related-party transactions, loans to and from
shareholders, and the company's accounting policies.2 At a minimum, these
statements should include an Income Statement and a Balance Sheet (see
Appendix A for descriptions of these statements and other accounting terms).
Companies might also be able to provide a Statement of Cash Flows
(sometimes called: "Statement of Changes in Financial Position" or "Sources
and Uses of Funds Statement").

If at all possible, obtain audited Financial Statements from the entity.
Audited statements are those which have been explicitly reviewed by a
certified public accountant for their conformance with Generally Accepted
Accounting Principles (GAAP). Audited statements will contain an auditor's
opinion, which will summarize how closely the entity's financials conform
with GAAP, and detail any questionable practices.3 Small, unincorporated
entities may only have unaudited statements.

If an entity has no financial statements awlable, request that they prepare
them. Even the smallest of sole proprietorships should be able to list and

1	Newly-formed companies will not have financial information going back several years. An
ABEL analysis of a new company will probably not be possible because of the lack of historical
financial data. Completing a detailed analysis as outlined in this guidance is particularly important
for such entities.

2	Also, financial statements may provide information on expenses not deducted on tax returns.
For example, EPA or other penalties will appear on financial statements, but not on tax returns, as
they are not tax-deductible.

3	If you are reviewing an entity's audited financials and find a "qualified" auditor's opinion
detailing questionable accounting practices, you should seek assistance from a financial analyst.

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value its assets, liabilities, revenues and expenses.4 Be cautious when you
. compare financial statements to tax returns, as the two can differ
considerably. Tax returns and financial statements often report on a
different time basis (i.e., calendar year versus fiscal year) or may use different
accounting conventions. Keep these differences in mind when you compare
the reponed information.

•	Dun & Bradstreet (D&B1 Report Dun & Bradstreet publishes information
about companies as a service to potential investors or creditors/ D&B
reports can be a good source of information on the entity's history, officers,
and affiliations; they can sometimes provide comparative financial data on
the entity as well. This information may help guide further research on the
relationships to other individuals and entities. When you review a D&B
report, keep in mind that companies voluntarily provide the underlying
information. In doing so, companies often try to present a positive picture
of their income position and potential earnings.

D&B can also provide industry profiles. Other sources of information on
industries and companies include Robert Morris Associates Annual
Statement Studies, Value Line. Standard & Poor, and industry associations.

•	Additional Financial Information. You might also find it helpful to review
materials prepared by the company to support a recent loan or debt financing
proposal, company forecasts of growth and/or expansion, and company plans
for major capital expenditures. Such information can provide another
measure of the company's anticipated future earnings.

It is important to note that accounting requirements differ for financial reporting and tax
reporting. As a result, a company's tax returns and financial statements may report different
numbers for some items.6 Our analysis is based on the entity's tax returns. Review of the entity's
financial statements is also important, however, as they may provide further detail on company
activities and its relationships with other entities.

4	Note the time periods covered by Income Statements and Balance Sheets; ideally these should
cover a full year of business operations. Statements covering only a portion of the year might not
adequately represent the seasonality of some businesses.

5	The National Enforcement Investigations Center (NEIC) can obtain D&B reports. The phone
number is 303/844-4517.

6	For example, reported income may be different from taxable income because of differences
, in claimed deductions.

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APPROACH AND METHODOLOGY

The approach used in this manual applies commonly used financial analytical techniques to
evaluate the financial condition of private entities. Once you have the necessary financial
information, you can begin an in-depth review of the entity. This review will vary somewhat based
on the type of entity, although the basic approach is very similar for each. Below, as an example,
we review the steps for analyzing a corporation.

Ownership and Operating Affiliations

In many cases, companies closely related to the violator will share its financial liabilities. So,
our first step in investigating an entity's financial position is to research its relationship with other
entities. The goal of this first step is to determine the nature and extent of each affiliate's
relationship, and whether you should also consider its resources in the ability to pay assessment.
Some affiliations may be strong; if the violator is a division, for example, including the parent
corporation is easy. Other cases may be more difficult to judge; for example, a case involving an
American firm that is a subsidiary of a foreign parent. In these cases it will be important to
determine the degree to which the parent company controls the financial health of the subsidiary.
It is not necessary to prove that the parent is in any way liable for environmental costs. Rather, you
are looking for financial resources available to the subsidiary outside its own legal structure.

Depending on the type of entity you are reviewing, the possible business affiliations will vary.
For corporations, parent-subsidiary relationships and joint ventures might be an issue. In addition,
the same person(s) may own "affiliated" corporations, and these might have significant financial
interactions. For partnerships and sole proprietorships, you should look at the financial position of
the general partners and/or the owner(s).

We will also want to examine an entity's "related party transactions." These transactions
could include the sale or purchase of goods and services from an entity that is related to the violator
via common ownership or family ties. Extensive related party transactions should be detailed in the
entity's financial statements. In other instances, you might have to do some research on the
violator's primary suppliers and customers to determine whether related parties are involved in the
business. In subsequent chapters we discuss in greater detail the possible business relationships that
different types of entities might have, and how they might affect your ability to pay assessment.

Business Assets

In this part of our investigation, we will look more closely at the assets recorded on the
entity's Balance Sheet, posing a number of questions about their value and use. In particular we
want to identify luxury assets (which may not be required for business purposes), undervalued assets,
and loans to officers or shareholders.7

7 In some instances, a company balance sheet may show few assets as compared to liabilities,
producing poor current and debt to equity ratios. You should review the historical financial
documents of this company closely. If the company is doing poorly, the controlling owners may be

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Luxury Assets

Luxury assets are those not necessary to the company's operations. Examples of such assets
include land (particularly land that the company is holding as an investment or is renting to a second
party), corporate airplanes or boats, and luxury vehicles. In examining these assets, consider whether
selling them would materially affect the underlying business (e.g., What would happen if the
company plane was sold?). If the asset is necessary to operations, consider how replacing it with
a less valuable asset would affect the firm. What funds might become available (net any related
loans) if the company officers replaced luxury company cars with more moderately priced models?

Undervalued Assets

Assets on the Balance Sheet are usually valued at their original purchase price ("cost") less
accumulated depreciation. This net figure is known as the asset's "book value." The book value of
an asset is highly influenced by the rate at which it is depreciated. Because companies can legally
depreciate many of their assets over periods that are shorter than the assets' useful lives, book values
can be considerably below market values. For example, suppose that a company buys a piece of
equipment for $50,000, and that the equipment is expected to last for 10 years. On its tax return,
the entity can depreciate the equipment over five years, with an annual straight-line depreciation
expense of $10,000. After five years, this equipment still hf£ a useful life of five years, and probably
has a positive fair market value.8 On the company's books, however, the asset is valued at zero.

The difference between book value and market value is generally not an issue for a
company's Current Assets. For Property, Plant and Equipment, however, consider asking the entity
-to provide a list specifying both book and fair market values for all its assets worth more than
$5,000. Assess for each major asset whether the stated market value seems reasonable, and whether
it is greater than the stated book value. Any differences represent additional equity for the
company.

Continuing with the example above, assume that the book value of the company's equity (i.e.,
its net worth after subtracting all liabilities) equals $200,000; and your review of the company's
itemized list of assets indicates that the property, plant and equipment are worth $15,000 more than
stated at book value. Add this $15,000 to company equity, increasing the total equity to $215,000.

Note that an asset examination does not imply that the company must use those assets as
a source of penalty funds. In identifying these assets, we are simply indicating that the company has
additional resources that could be used for penalty purposes. The company itself will determine how
it will actually provide those resources.

"liquidating" the firm's assets (i.e., converting them to cash) and distributing the proceeds among
company shareholders. Review the corporate tax return for sales of company assets (located on
Form 4797 • Sales of Business Property).

8 That is, it could be sold for some non-zero price.

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I .nans

Loans to Shareholders

Shareholders or corporate officers sometimes borrow from their companies at below-market
interest rates, or obtain funds from the corporation that they would not be able to secure from a
bank or other lender. Such loans must be reported on the Corporate Federal Income Tax return,
and should always be considered as a source of penalty funds. By calling these loans (and requiring
perhaps that these individuals borrow on the open market) the entity might be able to obtain
resources necessary for a penalty.

Loans from Shareholders

Corporate entities must also report loans from shareholders on their Federal Income Tax
returns. Shareholders can infuse funds into a company in one of two ways: (1) directly transfer
funds to the company; or (2) provide funds as a loan. In the first case, if the company fails (i.e.,
goes bankrupt) the loss that the shareholder can claim on his or her personal income tax return is
limited to $3,000 per tax year. In the second case, however, where the same shareholder makes a
business loan to the company and the company fails, the entire amount of the loan can be written
off as a loss. The potential tax advantages of such loans are obvious. The disadvantage of such a
loan is that the interest the shareholder earns on it is taxable as income. In our analysis we will
reclassify shareholder loans as business equity.

Business Expenses

The final worksheet examines the entity's expenses. A reduction in expenses (without a
corresponding reduction in revenues) will increase an entity's cash flow, thereby improving its ability
to pay. A company's expenses will be generally reported on its tax return, and on its Income
Statement. We base our analysis on the entity's tax return; however, you should compare the tax
return expense figures with those on the income statement (and any associated detail provided with
both) and investigate any significant discrepancies. Companies often state their expenses at the
highest allowable level for tax purposes to reduce their taxable income. If the documents that you
have do not itemize expenses, request that the company furnish detailed information on specific
expenses and service providers. Pay particular attention to officers' salaries, commissions, travel and
entertainment expenses, rent or charges to affiliated entities, dues and publications, and office
expenses. Look at whether any of these expenses (particularly rent, commissions, and sub-
contracting) have been paid to related parties.

Officers' Salaries

Officers' salaries should be consistent with salaries earned by similarly-placed individuals.
Professional societies and/or industry groups often collect statistics on earnings within their
industries. The officers' salaries should also reflect the officers' respective duties, and the amount
of time they spend on the job. Record this information on the worksheet and use it to determine
whether officers' salaries are appropriate.

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Other Expenses

Review the other expenses noted on the worksheet and try to evaluate their level and
necessity. Note especially any expenses paid to related parties. Examples of such expenses include
rent paid to an officer (i.e., the officer actually owns business property, perhaps under the name of
a different entity), and subcontracting or service agreements with affiliates or relatives. Such
"expenses" might actually disguise benefits or funds being paid to shareholders.

Data on average expenses within an industry or business are sometimes available from
Robert Morris Associates Annual Statement Studies (depending upon the industry), or from industry
associations. If you are uncertain about an expense, request additional information from the
company. Evaluating a company's expenses involves judgment, and some familiarity with business
operations. If you cannot determine whether an expense is reasonable, consult a financial analyst.
If you decide that some of the entity's expenses are excessive, estimate the amount by which they
can be reduced, and note these values on the worksheet.

Finally, remember that this expense review does not imply that the firm must reduce its
expenses to provide penalty funds. Rather, this review simply identifies alternative sources of funds.
The violator may choose a different approach from all those you identify. For example, the
company may decide to maintain current expenses, and take out a loan to cover the penalty.

CASE DISPOSITION

After reviewing the company's financial information and investigating its holdings and
transactions, you can reassess the violator's ability to pay. This assessment will vary depending on
the entity, but will generally consist of two steps: (1) a simple cash flow calculation; and (2) an
equity assessment. The steps described below focus on a corporation. The assessment of an
individual's cash flow and equity is detailed in Chapter 7.

Cash Flow Calculation

Part of the ABEL Model's ability to pay assessment is a cash flow calculation. ABEL
incorporates into its cash flow calculation several technical considerations, including the inflation
rate, reinvestment rate, and estimates the present value of an entities anticipated cash flows. Our
"manual" calculation is much easier. To estimate cash flow, w'e start with taxable income and add
back all "paper" deductions (e.g., non-cash expenses), and consider the effect of reduced expenses.

As a first step, we add back depreciation, amortization and depletion. These non-cash
expenses allow companies to account for asset value reductions over time (for example, business
equipment or depletable natural resources). Depreciation and amortization are legitimate business
costs, however, they are not cash payments and thus do not increase a company's annual cash
outflows. For that reason, we add these non-cash expenses back into income when computing net
cash flow. Similarly, depletion accounting is a way to allocate over time the original cost of

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acquiring and developing natural resources.9 Although depletion is a legitimate business cost, it
does not represent a cash outflow. Thus, we also add any depletion expenses back into a company's
income when computing cash flow.

As an example, assume that Company ABCs taxable income for a year is $86,000, and the
company claimed $4,115 in depreciation for that year. Adding back the latter amount gives us an
estimated cash flow of $90,115. This last amount, rather than the original taxable income figure,
represents ABCs actual pre-tax cash flow.10

Next, we adjust cash flow for any possible expense reductions that you have identified in your
"Beyond ABEL" investigation, yielding an estimate of cash flow that could possibly be generated if
expenses were reduced (assuming, of course, that revenues do not change). Suppose that your
investigation shows that the company can reduce officers' salaries by a total of $20,000, and other
expenses by another $5,000. Adding $25,000 to actual pre-tax cash flow ($90,115) yields an
estimated pre-tax cash flow figure of $115,115.

The final step is to adjust this figure for taxes.11 We do so by multiplying the pre-tax cash
flow by one minus the marginal tax rate.u Next we must add to this figure the "tax benefit" of any
depreciation, depletion or amortization deductions; plus any net operating losses carried forward
from previous years.13 To obtain this tax benefit figure, we multiply the total of these non-cash
deductions by the marginal tax rate. Company ABC did not claim any net operating loss cany-
forwards on its most recent tax return. Therefore, we estimate after-tax cash flow at $72,380
($115,115 x [1 - 0.385] + $4,115 x 0.385). This estimate does not imply that company cash flow will,
in fact, equal $72,380 next year, it simply provides an estimate of the resources that might be
available to the company if it continues to perform at its "adjusted" current level.

9	For example, a coal-mining company would record depletion expenses every year to account
for the coal that had been mined that year. Each year the mines are less valuable because they
contain less coal. Recording depletion is a way of capturing that loss.

10	Although we refer to this figure as "pre-tax cash flow" you should note that certain state and
local taxes can be deducted from income as a company expense. Thus "pre-tax" here refers to cash
flow before federal income tax payments.

11	Recall from your ABEL calculations that pollution control expenditures are tax deductible,
while a penalty is not. In general we will estimate an entity's ability to pay based on after-tax cash
flows.

u For corporations, we use 38-5 percent as the standard tax rate. For partnerships, sole
proprietorships and Subchapter S corporations we use 33 percent, the. highest marginal tax rate for
individuals.

13 A net operating loss carryforward is an ABEL input, and is claimed on Line 29a of the Form
1120 and Line 25a of the Form 1120A. Companies can claim some prior years' losses as current
deductions. The adjustment we state here accounts for tax effects of the non-cash loss.

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Equity Assessment

In assessing a company's equity we want to determine two things: (1) the value of assets that
could be liquidated without materially changing the business; and (2) the equity of the entity, based
on the value of remaining assets.

Assume that the fictitious ABC Company's equity equals $456,400. First we summarize
information you've gathered about unnecessary or luxury assets. Suppose you discover that ABC
owns and maintains four high-priced vehicles with a total current market value of $110,000, and no
associated loans. While these vehicles arc necessary for business-transportation purposes, you
believe that they could be replaced with more moderately-priced vehicles, which would have a
combined market value of $70,000. Replacing these vehicles would free up approximately $40,000.

Suppose that you also discover that the company has an outstanding loan of $12,000 to one
of its officers. Having the officer repay this loan would also make funds available for a penalty.

Now we want to recalculate the company's equity, based on the market value of its assets
and any possible reductions in liabilities. Based on your review of a detailed list of assets, you
actually decrease the value of the ABC's total assets from $1,205,000 to $1,153,000. This decrease
reflects the $40,000 downgrade in luxury business vehicles, and removal of the $12,000 officer's loan.
The combined amount ($52,QO0) is no longer considered a company asset, but rather becomes
"excess funds" available for a penalty. Your review of ABC's liabilities indicates that they are
legitimate and accurately represented. If we assume that these liabilities equal $748,600, we can
then recalculate stockholder's equity as $404,400, down from an original value of $456,000.
Company ABC may be able to borrow against this amount to produce funds for a penalty.

Case Disposition

The final section of the worksheet summarizes your results. In your investigation, you
estimated that ABC's after-tax cash flow for the coming year could be as high as $72,380. The value
of unnecessary or replaceable assets equals $52,000 ($40,000 from the vehicle sale plus $12,000 from
the officer loan), and the adjusted equity for the company is estimated at $404,400. The violator's
ability to pay pollution control and/or penalty costs can now be reassessed based on these
approximations.

If the violator is required to pay a penalty only, you can compare your ability to pay
assessment to the penalty figure directly, since a penalty is a "one-time" payment. However, if
environmental compliance costs are also involved (e.g., the company must invest in pollution control
equipment) you will need to consult your original ABEL analysis.

To adjust for required pollution control expenditures, do the following: First, re-run the
ABEL model without entering a penalty figure. Does the result still show that the violator will have
a difficult time paying environmental compliance costs? If so, compare your revised estimate of pre-
tax cash flow and cash available from asset liquidation to the pre-tax present value of compliance

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costs.14 Any indication that the violator will still experience difficulty is a serious issue, as the
violator must, at a minimum, come into compliance to continue operating. If the comparison
indicates that the violator is able to meet compliance costs, note on the worksheet any remaining
funds available for a penalty.

Remember that this summary does not imply that the company must liquidate assets or call
in loans to produce penalty funds. Rather, your review is aimed at more accurately assessing the
resources that the entity has to call upon. Any final ability to pay figure will clearly incorporate the
judgment of the enforcement team regarding what is appropriate given the violation.

GUIDANCE STRUCTURE

The approach described in this manual is organized around the various tax forms that an
entity might file: Form 1120 or 1120A for Subchapter C corporations, Form 1120S for Subchapter
S corporations, Form 1065 (with Schedule K-l) for Partnerships, and Form 1040 for Individuals and
Sole Proprietorships (with Schedule C for the latter).

The guidance is structured around the tax return forms primarily because each return (and
hence each type of entity) requires a "customized" analysis. Also, the tax forms let us reference
specific schedules and line items that are important to the analysis. As you proceed through the
worksheets, you will be able to consult the corresponding tax return forms.

14 The present value of compliance costs is simply the difference between 'Total ABEL Cash
Flow Generated" (column 2 of the ABEL summary analysis) and "ABEL Cash Flow Net of Pollution
Control Expenditures" (column 3). The difference between these figures at any probability level
equals the present value of compliance costs. Divide this amount by one minus the marginal tax rate
to estimate costs on a pre-tax basis.

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SUBCHAPTER C CORPORATIONS

CHAPTER 3

INTRODUCTION

Regular corporations (also known as Subchapter C corporations) can be large, multi-
company organizations or small, "closely-held" companies controlled by a few individuals or a family.
When such a business incorporates, it takes on the legal status of an individual. Therefore,
responsibility for paying debts and meeting other legal commitments rests with the corporation
alone, and does not extend to the corporate shareholders.1 In some respects, this liability limitation
makes a corporate ability to pay analysis fairly easy, as the financial resources of the owners need
not be assessed. However, relationships that corporations enter into with other business entities can
complicate the evaluation, and will sometimes lead to an analysis of these other entities.

You will most likely have completed an ABEL analysis for the corporation you are reviewing,
and are now consulting this document because of a negative or equivocal ABEL result. The
objective of this more detailed analysis is to determine if, despite a negative ABEL result, the
company can provide funds for a penalty by. for example, liquidating assets, reducing expenses, or
borrowing funds.

The first step in this analysis is to gather financial information. The corporation's Federal
Income Tax return Form 1120, and the relevant schedules, will already be on hand if you've
performed the ABEL analysis.2 You should also obtain the company's financial statements (e.g.,
income statement and balance sheet) for the past three to five years. Most corporations should be
able to provide audited statements (i.e., statements that have been reviewed by a certified public
accountant).

Consider also collecting other information on the company (e.g., Dun & Bradstreet or
Standard & Poor reports), as well as information on earning and expense averages, and performance

There are exceptions to this general rule. Under certain circumstances, liability for debts and
penalties can extend to the company's shareholders.

Note that some corporations may fill out the 1120A (Short-Form). The requirements for
completing the short-form are detailed on page 2 of the Instructions for Forms 1120 and 1120A
booklet.

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norms within the corporation's industry. These other sources could provide helpful information on
company affiliations and officers, and on industry trends. Once you have collected the necessary
information, you can begin the ability to pay evaluation using the worksheets at the end of this
chapter as a guide. Be certain, however, to read Chapter 2 before proceeding, as it contains a more
detailed explanation of the worksheet sections.

Section I - General Information

The first section of the worksheet summarizes basic information about the violator and the
information that has been collected:

•	Violator's name. On Line 1, enter the violator's name.

•	Address. On Line 2, enter the violator's address.

•	Principal business activity and product or service. On Line 3, enter the
violator's principal business activity, along with its product or service.3 This
information is on the Corporate Income Tax return Form 1120, Schedule K
lines 2b md 2c.4

•	Names of Officers. On Line 4 enter the names of the corporate officers and
the percent of stock owned. This information can be found on Schedule E
on Form 1120.

•	Original penalty amount Note on Line 5 the proposed penalty amount.

•	Penalty as a percent of sales. Divide the original penalty amount by the
company's total sales (item la on form 1120). Note the result on Line 6.

Section II - Financial Information

In this section of the worksheet we summarize the financial information available.

• Tax returns and schedules available. On Line 7, note the tax returns and
schedules provided, along with the year for each return.

3	Note that an ability to pay evaluation may be particularly difficult for certain businesses; for
example, agricultural corporations participating in government subsidy programs. You may want
to consult an expert for help in assessing these types of entities.

4	Throughout this chapter, references to Form 1120 are for the 1991 version of Form 1120. The
location of items may differ for previous years' forms.

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•	Financial Statements provided. On Line 8, list each available financial
statement (e.g., Balance Sheets, Income Statements and notes, Statement of
Change in Financial Position). Is this an audited statement? Note the
period covered by the statement, particularly if the statement covers only a
portion of the fiscal year.

•	Other violator or general industry information collected. On Line 9, list any
other material you have obtained. Examples include Corporate Annual,
Reports, Dun & Bradstreet reports, Value Line reports, Standard & Poors
industry data, etc. Note as well the dates covered by the document(s).

Section ITT - Ownership and Operating Affiliations

In this section we detail the relationships that the violator may have with other entities. This
section is particularly important for corporations that are connected to other entities through parent-
subsidiary relationships, joint venture agreements or other affiliations. These relationships are
described in greater detail below. You might be able to obtain information on these relationships
through the company's annual reports or its D&B report. In particular, you will want to determine
whether an affiliate is closely involved in the operations or finances of the violator.

Subsidiaries

A subsidiary is a corporation that is at least 50-percent owned by another company (i.e., at
least 50 percent of its common stock is owned by one other corporation). A subsidiary is wholly
owned if the parent company owns 100 percent of its stock. As with all corporations, a subsidiary
is an individual legal entity. As such, it may file separate tax returns. However, if a subsidiary is
more than 80 percent owned by the parent company, the parent may submit a consolidated tax
return that incorporates the subsidiary. For financial reporting purposes, according to generally
accepted accounting principles, a consolidated statement should be prepared if:

•	The parent owns more than 50 percent of the common stock of the
subsidiary;

•	The parent is able to exert control over the operation and management of
the company; and

•	The asset and equity structure of the subsidiary is not significantly different
from that of the parent.

The extent to which parent and subsidiary are related is quite important in ability to pay
cases. A parent company can often enter into purchasing contracts with a subsidiary, or manipulate
its finances, such that its financial condition appears worse than would be the case were the

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subsidiary an independent concern.3 Your evaluation of the parent-subsidiary relationship might
indicate that the parent company should be included in an ability to pay assessment of the
subsidiary. Although it is not EPA's policy to pronounce a parent firm liable for a subsidiary's
actions, it is proper to consider financial links that the subsidiary may have to the parent. It some
instances it might be difficult for enforcement staff to determine how involved the parent is in the
operations of a subsidiary. If you are unsure whether the parent should be included in the ability
to pay assessment, consult a corporate finance expert.

Affiliated Companies

Affiliated companies are those that are owned or controlled by the same individual or group.
Also known as "brother-sister" companies, control is demonstrated if:

•	Five or fewer persons (individuals, estates, or trusts) own at least 80 percent
of the voting stock or share value of each of two or more corporations; and

•	These five or fewer persons own more than 50 percent of the voting power
or share value of each corporation.

Brother-sister corporations can enter into the same type of purchasing agreements discussed
above for subsidiaries. In some instances, a corporation will choose to enter into a risky venture by
creating an affiliate, thereby limiting the liability for its other concerns. As with subsidiaries, you
should consider the financial links among a group of brother-sister corporations when determining
the ability to pay of a single affiliate.

Joint'Ventures

A joint venture is a business activity collectively established by two or more entities. Each
participating entity invests in the new company and shares in its income. Major decisions for the
company often require the backing of all owners. A joint venture operates as a separate entity, and
will generally submit its own tax returns. However, if an ABEL analysis indicates that a joint
venture is unable to provide funds for a penalty, the resources of the holding companies should be
evaluated.

Worksheet

An audited set of financial statements should include a section in the notes on any related
party transactions. This section will detail sales and purchases of goods and services from the
violator's affiliates. This section in the notes is helpful for two reasons: (1) it helps to identify the
violator's affiliates; and (2) it can be used to assess whether related party transactions were
conducted "at arms length" (i.e., at fair market rates). In this section of the worksheet, we detail

5 See the ABEL User's Guide. Chapter 5, for additional information on this topic.

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related-party transactions. If the notes to the Financial Statements do not provide this information
for the entity you are analyzing, you should request that the company provide the information.

•	Additional business concerns. Is this corporation affiliated with any other
business concerns? Check yes or no on Line 10.

•	Entity information. For each related entity, note the name and type. For
example:

Affiliate's Name

Type of Entity

MCG Demolition

Corporation

• Relationship and percentage owned. Describe here the relationship between
the two entities. Note also the percentage of stock owned by the affiliate.
Also note transactions between the affiliates. For example:

Relationship and
percentage ownership

MCG Demolition is a 'sister
firm of MCG Construction,
which owns 25 percent of its
stock. MCG Construction
accounts for 20% of MCG
Demolition's Sales. The two
companies frequently
purchase materials or
services from each other.

In the summary portion of this worksheet section (Line 11), discuss whether other entities should
be included in the ability to pay assessment for this violator. In some instances, this determination will
require advice from a financial expert. Continue to work on the ability to pay assessment of the violator
while you pursue information about the corporation's affiliates.

Section IV - Business Assets

In this section of the worksheet, we review the corporation's assets, and investigate their use and
worth. Remember that our intention is to determine the true ("market") value of the company's assets,
and the funds that might be available through liquidation of those that are unnecessary.

Part A - Loans to Shareholders

As explained in Chapter 2, loans to shareholders and officers are among the first assets that
should be tapped to fund a penalty. These loans must be reported on Form 1120, Schedule L. Item 6.

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Request that the violator provide additional information on the terms of these loans before completing the
following section on the worksheet:

•	Borrower. Enter the name of the officer or shareholder borrowing funds.

•	Date and amount of loan. Note the original amount of the loan and the date on
which funds were borrowed.

•	Interest rate. Note the interest rate at which the funds were borrowed.

•	Amount outstanding and date. Enter the amount outstanding Ooan balance) as
of the most recent financial statement or tax return.

•	Total outstanding loans to shareholders. Total here the outstanding amount of
all loans to officers and/or shareholders and enter this figure on Line 12.

Part B - Luxury Assets

In this section, our goal is to determine whether the company owns luxury or unnecessary assets,
or whether its balance sheet understates its assets, and thereby its net worth. As stated in Chapter 2,
luxury assets might include expensive or unnecessary vehicles, boats, planes, rental property, or other
assets not necessary to the company's operations.

In general, we will focus on the corporation's most valuable assets. Although it may be possible
to identify these assets using financial statements or tax returns, you might want to request that the
corporation provide a list specifying both the book and market value of assets valued at over $5,000, as
well as their use to the company. Information on asset use is important for determining whether the asset
is essential to company operations. Review the list that you receive carefully. Do the market values
seem reasonable? The worth of some assets can be double-checked against outside sources. For
example, vehicle values are published in industry "blue books," available at car dealerships. County or
local property assessors should be able to verify the value of land and/or buildings in their jurisdiction.
Industry analysts or associations can often estimate the value of business or industrial equipment.

In some instances, an entity will not want to provide detailed information on its assets, or it may
delay in doing so. If the penalty is significant, you may want to invest resources in researching state
transportation files, FAA records, or an asset database for this information.6 Remember that your ability
to pay analysis will only be as accurate as the data you receive. Remind entities that if they do not
provide financial data, you cannot evaluate their inability to pay claim.

6 Information America maintains an on-line asset locator database for a number of U.S. counties.
They can be contacted at 1-800/235-4008 for information on fees and data sources.

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Once you have reviewed a corporation's assets, complete the following block of information for
each luxury asset that you discover:

•	Asset and use. Describe the asset (for example, note make and year of vehicles
or equipment, location or property) and its use. In this section you may also
want to explain why you consider this asset to be a company "luxury."

•	Estimated market value. Note the market value of the asset and the source for
this information.

•	Balance due on loan. Note here any remaining loans outstanding on this asset.

•	Replacement cost. Estimate the cost of substituting luxury assets being used by
the company with less expensive replacements. For example; company officers
may need vehicles to conduct business, but they don't necessarily need luxury
vehicles.

•	Potentially available. To estimate funds potentially available for this asset,
subtract the outstanding loan amount from its market value.

•	Total potentially available net of replacement. Subtract any replacement costs
from the value of luxury assets and enter the net amount available on Line 13.

Part C - Undervalued Assets

In this section, note on the worksheet any discrepancies between the book value of an asset and
its market value:

•	Asset. Describe the asset (for example, note make and year of vehicles or
equipment, location of property).

•	Book value. Note the value as stated on the company's financial statements or
tax return (Schedule L on Form 1120).

•	Estimated market value. Note the market value of the asset and the source for
this information.

•	Total estimated excess value of assets. Calculate the difference between market
and book value for each undervalued asset and enter the sum on Line 14.

Section V - Loans from Shareholders

As noted in Chapter 2, loans from shareholders represent investment in the company, and thus,
for ability to pay purposes, can be considered company equity. These loans are claimed as a separate
liability on Form 1120, Schedule L, Item 18. You might also want to request additional information
from the corporation on loan terms and use of these funds.

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Lender. Enter the name of the officer or shareholder lending funds.

Date and amount of loan. Note the original amount of the loan and the date on
which funds were advanced.

Amount outstanding and date. Enter the amount outstanding as of the most
recent financial statement or tax return.

Total outstanding loans. Sum the outstanding amount of all loans from officers
and/or shareholders and enter the total on Line IS.

Revised liability total. Subtract the total loan amount from liabilities and enter
the revised total on Line 16 (Total liabilities equal Items 16 through 21 on Form
1120, Schedule L).

Section VI - Business Expenses ,

In this section of the worksheet we evaluate the level and necessity of the corporation's expenses.
Corporate expenses are listed as deductions on Form 1120, Items 12 through 26. Be certain to examine
any attached statements that detail expenses under Item 26 "Other deductions." Also, it is a good idea
to compare expenses on the tax return to those specified on the company's income statement.7 Any
significant discrepancies between the two should be investigated.

Part A - Officers' Salaries

•	Officer. Note each officer's name as it appears on Schedule E, Item la.

•	Percent of time devoted to business. Schedule E, Item lc details the time spent
by each officer on corporate business. Enter that information here.

•	Salary. Note here each officer's salary as it is claimed on Schedule E, Item If.

•	Amount of reduction. Evaluate a reduction in officers' compensation, based on
your review of the duties, time commitment, income, and percent ownership of
each officer.

7 As mentioned earlier, company financial statements may include some expenses that are not
included in corporate tax returns. Penalties payable to any government entity are an example of this
(e.g., OSHA or IRS penalties). You may want to include these expenses in your analysis. Also, be
aware that collection on IRS penalties generally takes precedence over EPA penalties. Finally, in
your comparison of tax returns and financial statements, note that annual tax returns and income
statements may not cover the same time periods. If the periods covered are different, consult a
financial analyst.

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•	Total reductions. Sum the reductions and enter the total on Line 17.

•	Justification for reductions. If possible, provide some information about each
officer's role or duties in the company and a justification of any possible salary
reductions. This information will not appear on the tax returns; however, it may
appear in the corporate annual report or the company's D&B report.

Part B - Other Expenses

In your review of company expenses, pay particular attention to travel and entertainment or
subsistence expenses, vehicle expenses, rent, office expenses and supplies, and dues and membership fees.
Such expenses can mask funds going to corporate officers or employees (for example, vehicle expenses
may include personal use of vehicles).

Also examine expenses paid to related parties, particularly subcontractor expenses, and expenses
for professional services.

•	Expense category. Review the corporation's expenses and list those that you
believe can be reduced without materially affecting the operations of the
company.

•	Amount expended. Note the current annual amount for each expense that you
believe can be reduced.

•	Possible reduction. Enter the amount by which you feel this expense could be
reduced without affecting company operations.

•	Total possible reduction in expenses. On Line 18, sum all possible expense
reductions.

•	Justification for reduction. In this space, describe your reasons for each
proposed reduction.

Section VII - Case Disposition

In this section of the worksheet we review the information we have gathered on corporate
holdings and transactions. As explained in Chapter 2, this summary leads to a reassessment of the
company's ability to pay. We will calculate (1) cash flow, and (2) corporate equity.

Part A - Cash Flow

If you conducted an ability to pay assessment of this violator using ABEL, then you already have
an estimate of the corporation's current and anticipated cash flow. In our analysis, we re-calculate cash
flow, using adjusted income and expense figures. This calculation is detailed in the steps below:

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•	Taxable income. On Line 19 enter taxable income as reported on Form 1120,
Item 28 (Taxable income before net operating loss and special deductions).

•	Depreciation, depletion and amortization expenses. In Chapter 2 we explained
that depreciation, depletion and amortization are expenses that do not affect a
company's cash flow. We therefore add these expenses back into company
income. Sura the amounts claimed on Form 1120, Lines 20 and 22 and enter the
sum on Line 20 of this worksheet.

•	Pre-tax cash flow. Sum the amounts on Lines 19 and 20. This total represents
the company's pre-tax cash flow.

•	Reductions in officer's salaries. On Line 22, enter the amount from Line 17
in Section VI, Part A of this worksheet.

•	Reductions in other expenses. On Line 23, enter the total from Line 18 in
Section VI, Part B of this worksheet. Recall from Chapter 2 that this amount
must be converted to an after-tax figure.

•	Estimated pre-tax cash flow. Add the amounts on Lines 22 and 23 above to
pre-tax cash flow.

•	Tax adjustment. Multiply this amount by one minus the corporate marginal tax
rate (1- 0.385) and enter the result on Line 25.

•	Non-cash deduction tax benefits. Add together the amount on Line 20 and any
net operating loss carry forward that has been claimed, and multiply the total by
the tax rate (0.385) and enter the amount on Line 26.

•	Estimated after-tax cash flow. Add lines 25 and 26 for estimated after-tax cash
flow.

As an example, assume that the MCG Construction Company's most recent tax return lists taxable
income before special deductions as $63,790. MCG has claimed a total of $44,500 in equipment
depreciation. Adding this to the company's declared taxable income gives us an adjusted income figure
of $108,290. This total represents MCG's pre-tax cash flow for that fiscal year.

Next we summarize possible expense reductions. According to its return, MCG is not currently
compensating it officers, so this expense cannot be reduced. Most other expenses also seem reasonable,
with the exception of the company's $178,211 insurance expense. You are not sure what policies are
included in this expense, so you ask the company for a list specifying the policies it holds. The
information provided indicates this expense includes whole-life insurance policies which the company has
purchased for its officers. These policies are not really a cost of doing business, but are rather a form
of officer compensation. You estimate that the company's insurance expense could be reduced by
$25,000 if officers were responsible for their own life insurance policies. If income remains fairly
constant and these expenses are reduced, then MCG could generate an estimated $133,290 in pre-tax cash
flow.

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To adjust for taxes we first multiply this amount by one minus the corporate marginal tax rate
(1-0.385 = 0.615) for an tax-adjusted subtotal cash flow of $81,973. We then add back the tax benefit
of MCG's $44,500 depreciation deduction, which equals $17,133 ($44,500 x 0.385). MCG has not
carried forward any losses from previous years, so it final estimated after-tax cash flow equals $99,106
($81,973 + $17,133).

Part B - Equity Assessment

In assessing MCG's equity we want to determine: (1) the value of assets that could be liquidated
in order to provide penalty funds; and (2) the true equity of the company, based on the value of
remaining assets.

Asset Liquidation

We determine funds that the corporation may be able to readily produce to fund a penalty as

follows:

•	Value of loans to shareholders. On Line 28, enter the amount from Line 12
in Section IV, Part A of this worksheet.

•	Estimated excess value of luxury or unnecessary assets. On Line 29, enter the
amount from Line 13 in Section IV, Part B of this worksheet.

•	Estimated funds available from liquidation. Sum the figures on Lines 28 and
29 and enter the total here. This estimate represents resources that could
possibly be directed towards a penalty payment.

Equity Valuation

Here we summarize other information gathered on company assets and liabilities in order to more
accurately estimate company equity.

•	Adjusted company assets. Enter the total value of company assets. To
calculate this figure, subtract the value of assets liquidated (Line 30) from the
value of company assets as it appears on Form 1120, Schedule L, Item 15.

•	Estimated incremental value of undervalued assets. Enter the value on Line
14 of Section IV, Part C of this worksheet.

•	Adjusted total assets. Sum the figures on Lines 31 and 32 for an estimate of
the company's assets.

•	Adjusted liabilities. Enter the revised total for company liabilities from Line 16
in Section V of this worksheet.

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Estimated adjusted equity. Subtract Line 34 from Line 33 and enter this figure
on Line 35. This is an estimate of the company's equity, based on adjustments
to assets and liabilities.

Continuing with our example company, MCG Construction, we illustrate the equity assessment.
MCG's assets, per its balance sheet, are $542,700; its liabilities equal $346,960, for total equity of
$195,740. Your review of the company's assets indicates that MCG does not have any apparent luxury
or unnecessary assets. However, several years ago the company lent $15,000 to one of its officers.
Approximately $11,000 is still outstanding on this loan, which was made at an annual interest rate of
three percent. Liquidating this loan (i.e., calling it in) will reduce notes receivable (a company asset) by
$11,000. We assume that this amount will be directly applied to a penalty or environmental costs, and
therefore include it in assets to be liquidated. Subtracting the $11,000 loan from our original asset figure
of $542,700 gives us a revised asset figure of $531,700. All liabilities on the company statements appear
legitimate, and you calculate a new equity total of $184,740. MCG could potentially borrow funds
against this amount.

Part C - Case Disposition

The final section of the worksheet summarizes your results. In your investigation, you estimated
MCG's after-tax cash flow at $99,106 (enter this amount on Line 36). You also determined that MCG
could furnish $11,000 by calling in a loan made to one of its officers (enter this on Line 37).
Adjustments that you made to the company's assets indicate that equity in MCG Construction equals
approximately $184,740 (enter this on Line 38). Compare these amounts to the assessed penalty figure
and/or environmental compliance costs as discussed in Chapter 2. As a final step, note whether this
investigation completes the analysis or if analysis of affiliated entities is required.

Remember that this summary does not imply that the company must produce funds through the
sources you have identified. Rather, your review is aimed at more accurately assessing the resources that
the entity has to call upon. Any final ability to pay figure will clearly incorporate the judgment of the
enforcement team regarding what is appropriate given the violation and original penalty amount.

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CORPORATION

EXTENDED ABEL ANALYSIS

Section I. Genera] Information

1. Violator's name:

2. Address:

3. Principal business activity and product or service (1120 Schedule K lines 2b and 2c):

4. Names of Officers (1120 Schedule E or attached Statement)

Percent ownership of stock





















5. Original penalty amount



6. As a percent of sales (penalty + 1120 line la)



Section II. Financial Information

7. Tax returns and schedules available

Year Prepared



























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CORPORATION
EXTENDED ABEL ANALYSIS

Section II. Financial Information (continued)

8. Financial Statements provided

Audited? Y or N

Period(s) covered

































9. Other violator or general industry information collected and date of document(s):

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CORPORATION
EXTENDED ABEL ANALYSIS

Section III. Ownership and Operating Affiliations (from tax form, Financial Statements and/or D&B
report)

Additional business concerns (check and answer where applicable)

Yes

No

10. Is this corporation affiliated with any other business concerns (e.g.,
subsidiaries, parent corporations, sister companies, joint ventures, etc.)







If Yes, provide the following information:

Affiliate's Name

Type of entity

Relationship and
percentage ownership



















11. Summary: Discuss possible expansion of Ability to Pay analysis, and additional
information required.

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CORPORATION
EXTENDED ABEL ANALYSIS

Section IV. Business Assets (Use data from 1120 Schedule L» compare with Financial Statements)

Part A. Loans to Shareholders

Borrower

Date and
amount of loan

Interest
rate

Amount
outstanding (date)









































12. Total outstanding loans to shareholders



Part B. Luxury Assets

Asset and use

Estimated market
value

Balance due on
loan

Replacement
cost

Potentially
available



















































13. Total potentially available net of replacement





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CORPORATION

EXTENDED ABEL ANALYSIS

Section IV. Business Assets (continued)

Part C. Undervalued Assets

Asset

. Book value

Estimated
market value

Value
difference

¦















































14. Total estimated excess value or assets



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CORPORATION
EXTENDED ABEL ANALYSIS

SectioB V. Loans from Shareholders

Lender

Date and amount
of loan

Amount outstanding
(date)

























15. Total outstanding loans



16. Revised liability total



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::s ¦99¦*

Schedule A

Cost of Goods Sold (See instructions )

3

4

5

6

7

8

9a

I 4

8

inventory at' Degmning of year	. .

P.urcnases	'	...

Cost of laDor	-

Additional section 263A costs isee instructions) lartacn scneCule)

Otner costs lattacn scneCute). -	...

Total. Add unes 1 tnrough 5 . .	...

inventory at end of vear		

Cost ot goods sold. Suotract nne 7 from line 6 Enter nere and on line 2. page 1
ChecK all metnoos used for valuing closing inventory-
iv _ Cost

in) Hi Lower of cost or market as descnDed in Regulations section 1.471-4

(i»j 	¦¦ Writedown of suonormal" goods as aescnoed m Regulations section 1 471-2(c)

dvi Hi Otner (specify metnoo used and attach explanation) ~ 	

CnecK if tne LIFO inventory method was adopted tnis tax year for any goods (if checked, attach Form 970).
it trie LIFO inventory metnod was used for this tax year, enter percentage (or amounts) of closing

inventory computed under LIFO	. . . ,		

Do tne rules of section 263A (for proDerty produced or acouired for resale) apply to tne corporation?

9c

~ ~

Was tnere any cnange m aeterminmg auantities. cost, or valuations oetween opening and closing inventory9

K "Yes.1 attacn exDianation	\			

LJ Yes n No
	1 Yes Q No

Schedule B

Other Information

Yea

1	Cneck metnod of accounting (a) C-Cash (b) L_I Accrual (c) Q Other (specify) ~	

2	Refer to tne list in tne instructions and state your onncipal.

(al Business activity ~ 	 (t>) Product or service ~ 	

|3 Did you at tne end of the tax year own. directly or indirectly. 50% or more of the voting stock of a domestic corporation?
(For rules of attnbution. see section 267(c).) if "Yes." attach a schedule showing: (a) name, address, and employer
identification number and (b) percentage owned

4	Were you a member of a controlled group sub|ect to tne provisions of section 1561?	

5	At any time aunng tne tax year, did you nave an interest in or a signature or other authority over a financial account
m a foreign country isucn as a bank account, securities account, or other financial account)? (See instructions for
exceotions and filing requirements for form TD F 90-22.1.)		 	

if "Yes." enter tne name of the foreign country ~ 	

6	Were yOL, tne grantor ot. or transferor to. a foreign trust that existed dunng the current tax vear. wne»her or not you
nave any Deneficiai interest in if If "Yes. you may nave to file Forms 3520. 3520-A, or 926 ....

7	Cneck tnis oox if the corporation nas filed or is reouired to file Form 8264, Application for Registration of a Tax
Shelter	....	.... 	~ l_'

8	Check this oox if the corporation issued publicly offered debt instruments with onginai issue discount . • • ~ i_l
if so. tne corporation may have to file Form 8281, information Return for Publicly Offered Onginai Issue Discount
instruments.

9	if tne corporation: (a) filed its election to be an S corporation after 1986, (b) was a C corporation before it elected to
oe an S corporation or the corporation acouired an asset with a oasis determined by reference to its basis lor tne
Dasis ot any otner property) In the hands of a C corporation, and (c) nas net unrealized built-in gain (defined in section
1374(d)(1)) in excess of tne net recognized built-in gain from pnor years, enter tne net unrealized built-in gam reduced
Dy net recognized built-in gain from pnor years (see instructions)	~ S.	

10	Check tnis oox if tne corporation had subcnaoter C earnings and profits at the close of the tax year (see

instructions) ¦	¦ . . .	. . ¦ .	 	 	~

Designation of Tax Matters Person (See instructions.)

Enter oeiow tne snarenoioer oesignated as tne tax matters person (TMP) for tne tax year of tnis return:

Name of
designated TMP

~

identifying k
number of TMP f

Address of
aesianated TMP

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1120S

U.S. Income Tax Return for an S Corporation

For calendar year 1991. or tax year Oeqinrtmg 	1991. and ending 	 .19 ...

~ See seoarate instructions.

:mB No. -.;45-0i3O

"1191

A Oate or election as an
S coiuoration

Use Name

IRS

libel

C Employer identifies Uun numr

Other- i Numoer. street, ana room or suite no. (if a P 0 oox. see sage 8 of tne instructions.!
wise.

0 Oate incorooratea

9 Business ccce no see
Soecitic instructions!

J C.ty or town. state. ana ZIP coae
typa. 1

E Total assets isee Soecrtc instructions!

S 1

F ChecK aopncaDie ooxes: 11) I	 Initial return (2) l_J Final return (3) D Change in address \4) Q Amended return

GCdecK tms :ox n ;ns S corooration is suoiect to tne consolidated audit procedures ol sections 6241 ttirougn 6245 (see instructions oefore cnecxmg mis oox)' ¦ ~
H Enter numoer of sharenoiders in the corpdration at end of the tax year ¦ 	 	. . . »

~

Caution: incluae only trade or ousiness income ana expenses on lines 1a througn 21. See the instructions for more information.

1	a	Gross receipts or saiesi	!_! b Less returns and allowancesi	i	: c Bal»- 1c '

2	Cost of goods sold (Schedule A. line 8)	

3	Gross profit. Subtract line 2 from line ic	

4	Net gam ilossi from Form 4797, Part 11. line 18 (attacn Form 4797) .... ....

5	Other income (see instructions) (attacn scneaule)	

6	Total income (loss). Comoine lines 3 through 5	¦			¦ ~

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14a	Depreciation (see instructions) . 	

b	Depreciation claimed on Schedule A and elsewhere on return

c	Subtract line 14b from line 14a	

1S	Depletion (Oo not deduct oil and gas depletion.) 	

19	Advertising .		

17	Pension, profit-shanng. etc.. plans . ... 	

18	Employee benefit programs ... 	

19	Other aeductions (attacn scnedule)	 	

20	Total deductions. Add lines 7 througn 19		

21	Ordinary income ilossi from trade or Business activities. Subtract line 20 from line 6

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Add lines 22a and 22b (see instructions for additional taxes*

Payments: ,

1991 estimated tax payments ....		

Tax aeposited with Form 7004 . 	

Credit for Federal tax on fuels (attacn Form 4136)	

Add lines 23a through 23c . 	

Estimated tax penalty (see page 3 of instructions). Check if Form 2220 is attached ~ Q
' 25 Tax due. If the total of lines 22c and 24 is larger than line 23d. enter amount owed. See

instructions for depositary method of payment • 	~

: 26 Overpayment If line 23d is larger than the total of lines 22c and 24, enter amount overpaid ~
27 Eiter amount of line 26 you wanr Credited to 1992 ettimated lai 	I Refunded >

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Cat. No. 11510H

-orm 1120S H9911

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SUBCHAPTER S CORPORATIONS	CHAPTER 4

INTRODUCTION

Corporations that meet specific criteria can elect to be organized as Subchapter S
corporations. Specifically, the corporation must:

•	Be a domestic corporation.

•	Have only one class of stock.

•	Have no more than 35 shareholders.

•	Have as shareholders only individuals, estates, and certain trusts.
Partnerships and corporations cannot be shareholders in an S corporation.

•	Have shareholders who are citizens or residents of the United States.

In general, Subchapter S corporations are fairly sophisticated vehicles for conducting business, and
analyzing their ability to pay can be difficult. Income from a Subchapter S corporation is
apportioned to shareholders, and is reported and taxed on each shareholder's individual tax return.
However, this "income" does not represent a cash payment to the shareholder, as would wages, for
example. All or much of the income may be retained within the corporation. Because this income
is taxed at the shareholder level, though, a share must be claimed on each individual tax return.
Any cash or property distributed to shareholders will be recorded as such on the Form 1065
Schedule K (Line 17 - Total property distributions other than dividends, and Line 19 - Total
dividend distributions paid from accumulated earnings and profits).

Individuals sometimes form Subchapter S corporations as tax shelters, as business losses can
offset shareholders' income and thereby reduce their taxes. Often, too, small businesses initially
incorporate under Subchapter S, and later reorganize under Subchapter C as t-he business begins to
generate income.

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Because analyzing Subchapter S corporations can be complicated, we recommend that you
seek advice from a financial analyst under the following conditions:

•	If the corporation did not have S corporation status for the entire year of its
most recent tax return;

•	If any distributions of property are reported on Line 17;

•	If a high percentage of the corporation's income is investment income (i.e.,
if the sum of Lines 4 through 4f account for more than 30 percent of total
income); or

•	If the corporation is generating a loss, rather than generating income (i.e.,
if it is reporting negative income).

Since Subchapter S corporations may have no more than 35 shareholders, they are often
organized and controlled by families or small groups of individuals. The term "closely-held" refers
to those corporations that are controlled by one person or very few individuals. It is therefore
important with such corporations to investigate potential intermingling of corporate and individual
shareholders' funds. As discussed in Chapter 1, such intermingling could "pierce the corporate veil"
that protects shareholders from personal responsibility for the corporation's liabilities. We pay
particular attention to this possibility here, as such intermingling is more likely to occur in small,
closely-held corporations.

You probably will have already performed an ABEL analysis for the Subchapter S
corporation and are consulting this document to identify additional sources of funds. This more
detailed analysis provides a methodology for evaluating the company's income, assets and expenses
to determine if they are reasonable. Small companies may be able to manipulate financial
information to avoid taxes, or to mask funds going directly to shareholders. This analysis will
highlight those items which should be investigated more carefully before making a final ability to
pay assessment.

Since corporate financial information will provide the basis for this analysis, you must first
collect all relevant materials. If you have performed an ABEL analysis you will already have the
corporation's Federal Income Tax return Form 1120S and the relevant schedules on hand. These
will be our primary source of information, although financial statements would also be useful.
Audited statements (i.e., those that have been reviewed by a CPA for their conformance with
generally accepted accounting principles) are the most reliable, but at the very least the Subchapter
S corporations should be able to provide unaudited financial statements.

Subchapter S corporations are private entities. As a result, independent financial
information may be more limited than that available for publicly-traded corporations. Dun &
Bradstreet provides financial information for a number of private companies. These reports often
include corporate history, financial statistics and a listing of corporate officers. In addition you may
be able to locate industry earnings and expense averages and performance norms for similar types
of businesses. These sources could provide useful information to supplement your ability to pay
analysis.

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Once you have collected the necessary information, you can begin the ability to pay
evaluation using the worksheets at the end of this chapter as a guide. Be certain before proceeding,
however, that you have read Chapter 2, as it contains a more detailed explanation of the worksheet
sections.

Section I - Genera) Information

The first section of the worksheet summarizes basic information about the violator and the
information that has been collected:

•	Violator's name. On Line 1, enter the violator's name.

•	Address. On Line 2, enter the violator's address.

•	Principal business activity and product or service. On Line 3, enter the
violator's principal business activity, along with its product or service.1 This
information is on the 1991 Corporate Income Tax return form 1120S,
Schedule B lines 2a and 2b.

•	Original penalty amount. Note on Line 4 the original penalty amount
proposed.

•	Penalty as a percent of sales. Divide the original penalty amount by the
company's total sales (item la on form 1120S). Note the result on Line 5.

Section II - Financial Information

In this section of the worksheet we summarize the available financial information:

•	Tax returns and schedules available. On Line 6, note the tax returns and
schedules provided, along with the year for each return.

•	Financial Statements provided. On Line 7, list each available financial
statement (e.g., Balance Sheets, Income Statements and notes, Statement of
Change in Financial Position). Is this an audited statement? Note the
period covered by the statement, particularly if the statement covers only a
portion of the fiscal year.

•	Other violator or general industry information collected. On Line 8, list any
other material you have obtained and/or researched (e.g., Dun & Bradstreet
reports, industry statistics, etc.) Note also the dates covered by the
documents.

1 Note: you may want to consult a financial analyst if the Subchapter S corporation is a farming
or agricultural operation, as these entities can be difficult to analyze.

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Section EH - Ownership and Operating Affiliations

Unlike Subchapter C corporations, Subchapter S corporations are restricted from entering!
into certain business relationships. In general, a Subchapter S corporation cannot be a member ol
an affiliated group of corporations and therefore cannot have subsidiaries.2 In addition, the
corporation itself cannot be a subsidiary or joint venture because the individual shareholders cannot
be corporations or partnerships. While these constraints limit the organizational complexity of a
Subchapter S corporation, they do not restrict its affiliations entirely. A Subchapter S corporation
may still hold stock in other corporations, and can be a member of a partnership. For tax purposes,
companies are assumed to be affiliated with other organizations if they own 50 percent or more of
the stock in the entity, or if they are a partner.3 Such affiliated entities should be reviewed if you
decide to extend your ABEL analysis beyond the Subchapter S corporation itself.

Part A - Corporate Affiliates

In this section provide any information you have obtained regarding corporate affiliates and
the relationships they have to the Subchapter S corporation. First, on Line 9, check whether the
corporation is affiliated with any other entity.

•	Affiliate's name. On Line 10 enter the name of the affiliate.

•	Type of entity. Enter the type of organization (e.g., corporation,
partnership).

•	Relationship and percent ownership of stock. List the percent of stock in the
affiliated entity owned by the Subchapter S corporation. Provide any
additional information regarding the relationship between the two entities,
particularly if they are involved in any transfers of goods and services.

Part B - Shareholders and Officers

This section of the worksheet asks for detailed information on majority shareholders (i.e.,
those owning more than 20 percent of the stock), their affiliates (if known), and the distributions
they receive from the business. This section will enable you to identify the key shareholders who
may be included in the extended ABEL analysis, should personal and corporate funds overlap.
Specific shareholder information can be found on the K-l Schedules, attached to the Subchapter S
corporation tax returns. You might also be able to obtain information on corporate officers through
D&B reports:

2	There are exceptions to this rule in cases where a subsidiary is inactive, a former Domestic
International Sales Corporation (DISC), or a foreign corporation. For more information consult Tax
Information on S Corporations. Publication 589 from the IRS.

3	For more information regarding the requirements on corporate affiliations and related parties
see Tax Information on S Corporations. Publication 589 from the IRS.

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•	Shareholder and corporate position. Enter on Line 11 the name(s) of the
shareholders owning 20 percent or more of the company's stock. Note also
whether each is a corporate officer (this information might be noted on the
D&B report).

•	Percent ownership. Schedule K-l, Item A specifies the shareholders
ownership share in the business.

•	Dividends/distributions. Note property distributions to each shareholder as
reported on Line 17 of each individual Schedule K-l.

•	Information regarding shareholder affiliations. Note here any information
that has been provided regarding majority shareholders' affiliations, and
whether the Subchapter S corporation does any business with the affiliated
entity.

Section IV - Business Assets

In this section of the worksheet, we review the corporation's assets and investigate their use
and worth. Remember that our intention is to determine the true ("market") value of the company's
assets, and the funds that might be available through liquidation of any that are unnecessary.

Part A - Loans to Shareholders

As explained in Chapter 2, loans to shareholders and officers are among the first assets that
should be tapped to fund a penalty. These loans must be reported on Form 1120S, Schedule L,
Item 7. Note on the worksheet some detailed information about these loans:

•	Borrower. Enter the name of the officer or shareholder borrowing funds.

•	Date and amount of loan. Note the original amount of the loan and the date
on which funds were borrowed.

•	Interest rate. Note the interest rate at which the funds were borrowed.

•	Amount outstanding and date. Enter the amount outstanding as of the most
recent financial statement or tax return.

•	Total outstanding loans. Total here the outstanding amount of all loans to
officers and/or shareholders and enter this figure on Line 13.

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Part B - Luxury Assets

In this section, our goal is to determine whether the company is holding luxury or
unnecessary assets, or is undervaluing its assets and thereby understating its equity. As stated in
Chapter 2, luxury assets might include luxury or unnecessary vehicles, boats, planes, rental property,
or other assets not necessary to the company's operations.

In general, we will focus on the corporation's more valuable assets. Although it may be
possible to do so using financial statements or tax returns, you might want to request that the
corporation provide a list specifying both the book and market value of assets valued at over $5,000,
as well as their use to the company. Information on asset use is important for determining whether
the asset is essential to company operations. Review the list that you receive carefully. Do the
market values seem reasonable? The worth of some assets can be double-checked against outside
sources. For example, vehicle values are published in industry "blue books," available at car
dealerships. County or local property assessors should be able to verify the value of land and/or
buildings in their jurisdiction. Industry analysts or associations can often estimate the value of
business or industrial equipment.

In some instances, an entity will not want to provide detailed information on its assets, or
it may delay in doing so. If the penalty is significant, you may want to invest resources in
researching state transportation files, FAA records, or an asset database for this information.4
Remember that your ability to pay analysis will only be as accurate as the data you receive. Remind
entities that if they do not provide financial data, you cannot evaluate their inability to pay claim.

Once you have reviewed a corporation's assets, complete the following block of information
for each luxury asset that you discover:

•	Asset and use. Describe the asset (for example, note make and year of
vehicles or equipment, location or property) and its use. In this section you
may also want to explain why you consider this asset to be a company
"luxury."

•	Estimated market value. Note the market value of the asset and the source
for this information.

•	Balance due on loan. Note here any remaining loans outstanding on this
asset.

•	Replacement cost Estimate the cost of substituting luxury assets being used
by the company with less expensive replacements. For example, company
officers may need vehicles to conduct business, but they don't necessarily
need luxury vehicles.

4 Information America maintains an on-line asset locator database for a number of U.S. counties.
They can be contacted at 1-800^235-4008 for information on fees and data sources.

4.-6

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•	Potentially available. To estimate funds potentially available for this asset,
subtract the outstanding loan amount from its market value.

•	Total potentially available net of replacement Subtract any replacement
costs from the value of luxury assets and enter the net amount available on
Line 14.

Part C • Undervalued Assets

In this section, note on the worksheet any discrepancies between the book value of an asset
and its market value:

•	Asset Describe the asset (for example, note make and year of vehicles or
equipment; location of property).

•	Book value. Note the value as stated on the company's financial statements
or tax return (Schedule L on Form 1120S).

•	Estimated market value. Note the market value of the asset and the source
for this information.

•	Total estimated additional value of assets. Calculate the difference between
market and book value for each undervalued asset and enter the sum of all
values on Line 15.

Section V - Loans from Shareholders

As noted in Chapter 2, loans from shareholders represent investment in the company, and
thus for ability to pay purposes can be considered company equity. These loans are claimed as a
separate liability on Form 1120S, Schedule L, Item 19. You might want to request additional
information from the corporation on loan terms and use of these funds.

•	Lender. Enter the name of the officer or shareholder lending funds.

•	Date and amount of loan. Note the original amount of the loan and the date
on which funds were advanced.

•	Amount outstanding and date. Enter the amount outstanding as of the most
recent financial statement or tax return.

•	Total outstanding loans. Total here the outstanding amount of all loans from
officers and/or shareholders. Enter this amount on Line 16.

•	Revised liability total. Subtract the total loan amount from liabilities and
enter the revised total on Line 17 (Total liabilities equal Items 16 through 21
on Schedule L, Form 1120 S).

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Section VI - Business Expenses

In this section of the worksheet we evaluate the level and necessity of the corporation's
expenses. Corporate expenses are listed as deductions on Form 1120S, Items 7 through 19. Be
certain to examine any attached statements that detail expenses under Item 19 "Other deductions."
Also, it is a good idea to compare expenses on the tax return to those specified on the company's
income statement.3 Any significant discrepancies between the two should be investigated.

Part A - Officers' Salaries

Here we assess compensation paid to officers for the duties they perform. Officers of a
Subchapter S corporation may or may not be shareholders in the corporation. As officers they earn
a salary, which is different from income earned by shareholders. Unlike the 1120 tax form for
Subchapter C corporations, the 1120S does not request detailed information regarding officer
compensation. Total officer compensation is noted on line 7 of the 1120S; however, this
compensation is usually allocated among multiple officers.

To fill out this portion of the worksheet you will need to request detailed information
regarding officers' compensation and duties. Dun and Bradstreet reports might provide a list of
corporate officers. With this information you can assess whether compensation is reasonable based
on officers' duties, and whether it can be reduced to provide additional funds for penalty payment.

•	Officer. Note each corporate officer's name as it appears on the D&B report
or corporate financial statements.

•	Salary. Note the salary each officer receives for performing duties.

•	Amount of reduction. Estimate a reduction in each officer's compensation, based
on their respective duties, time commitment, income and percent stock ownership.

•	Total reduction in officer's salaries. On Line 18, sum all possible reductions
in officers' salaries.

•	Summarize duties and provide justification for reductions. Summarize the
officers' duties and time devoted to corporate activities. Provide justification
for any proposed reductions.

5 Be aware in your comparison that annual tax returns and income statements may not cover the
same time periods, or may be based on different accounting methods.

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Part B • Other Expenses

In your review of company expenses, pay particular attention to travel and entertainment or
subsistence expenses, vehicle expenses, and office expenses and supplies.6 Such expenses can mask
funds going to corporate officers or employees (for example, vehicle expenses may include personal
use of vehicles). Examine as well any expenses paid to a related party; particularly expenses paid
for subcontractors or professional services.

•	Expense category. Review the corporation's expenses and list those that you
believe can be reduced without materially affecting the company's operations.

•	Amount Note the current annual amount for each expense that you believe
can be reduced.

•	Possible reduction. Enter the amount by which you feel this expense could
be reduced without affecting company operations.

•	Total possible reduction in expenses. On Line 19 sum all possible reductions
in expenses.

•	Justification for reduction. In this space, list your reasons for each proposed
reduction.

Section VII - Case Disposition

In this section of the worksheet we review the information we have gathered on corporate
holdings and transactions. As explained in Chapter 2, this summary leads to a reassessment of the
company's ability to pay. This analysis has two steps: (1) a cash flow calculation, and (2) an equity
assessment.

Part A - Cash Flow

If you conducted an ability to pay assessment of this violator using ABEL, then you already
have an estimate of the corporation's current and anticipated cash flow. In our analysis, we re-
calculate cash flow using adjusted income and expense figures. This calculation is detailed in the
steps below:

•	Taxable income. On Line 20 enter taxable income as reported on Form
1120S, Item 21 (Ordinary income [loss] from trade of business activities).

•	Depreciation, depletion and amortization expenses. In Chapter 2 we
explained that these expenses do not affect a company's cash flow. Therefore

* Note that corporations can only deduct 80% of certain travel and entertainment expenses.
Therefore, a lower expense might be reported on the tax return than is reported on the financial
statements.

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we add these expenses back into company income. Sum the amounts claimed
on Form 1120S, Lines 14a and 15 and enter the total on Line 21.

Pre-tax cash flow. Sum the amounts on Lines 20 and 21. This total
represents the company's pre-tax cash flow.

Reductions in officers' salaries. On Line 23, enter the amount from Line 18
in Section VI, Part A of this worksheet.

Reductions in other expenses. On Line 24, enter the total from Line 19 in
Section VI, Part B of this worksheet.

Estimated pre-tax cash flow. Add the amounts on Lines 23 and 24 above to
estimate pre-tax cash flow.

Tax adjustment Multiply the amount on Line 25 by one minus the highest
marginal income tax rate for individuals (1 - 0.33 = 0.67) and enter the result
on Line 26.7

Non-cash deduction tax benefits. Multiply the amount on Line 21 by the tax
rate (0.33) and enter the result on Line 27.

Estimated after-tax cash flow. Add together Lines 26 and 27, and enter the
result on Line 28.

The corporation might be able to produce this amount in the coming year if income remains
steady and expenses are reduced. Recall that this income is not distributed as cash to shareholders.
Although shareholders must pay taxes on their portion of income, the cash they receive is recorded
as distributions and dividends on Schedule K.

As an example, let's assume, that Clever Designs Advertising Company's most recent tax
return lists net income from trade or business activities of $87,550. Clever Designs has claimed a
total of $22,450 in equipment depreciation. Adding this to the company's declared ordinary income
gives us an adjusted income figure of $110,000. This total represents Clever Designs' pre-tax cash
flow for the fiscal year.

Next we summarize possible expense reductions. According to its return, Clever Designs is
not currently compensating its officers (the company is run by two officers, each of whom owns 50
percent of the stock), so this expense cannot be reduced. Most other expenses also seem
reasonable, with the exception of the company's $17,500 travel and entertainment expense. Upon
investigation you find that $7,500 of this amount was used for vacations taken by the company's
president and her family. Therefore, you determine that travel and entertainment expenses can be
reduced by this entire amount. If income remains fairly constant and expenses are reduced, then

7 We use the individual income tax rate (rather than the corporate rate) because income from
Subchapter S corporations is taxed at the shareholder level.











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Clever Designs could generate an estimated $117,500 in pre-tax cash flow ($110,000 + $7,500).
Adjusting for taxes, this amount translates into $78,725 ($117,500 x 0.67). Next we calculate the tax
benefits of Qever Designs' non-cash deductions. We multiply the depreciation expense by the tax
rate ($22,450 x 0.33) for a tax benefit of $7,409. We add this amount to the $78,725 for a total
estimated after-tax cash flow of $86,134.

Part B • Equity Assessment

In assessing Qever Design's'equity we want to determine: (1) the value of assets that could
be liquidated to provide penalty funds; and (2) the tnie equity of the company, based on the value
of remaining assets.

Asset Liquidation

We determine funds that the corporation may be able to readily produce to fund a penalty
as follows:

•	Value of loans to officers or shareholders. On Line 29, enter the amount
from Line 13 in Section IV, Pan A of this worksheet.

•	Net value of luxury or unnecessary assets. On Line 30, enter the amount
from Line 14 in Section IV, Part B of this worksheet.

•	Estimated funds available from liquidation. Sum the figures on Lines 29 and
30 and enter the total on Line 31. This estimate represents resources that
could possibly be directed towards a penalty payment.

Your investigation of Qever Designs indicates that they have one outstanding loan to a
shareholder in the amount of $7,600. Assuming that this loan can be liquidated and the shareholder
can obtain funds elsewhere, this adjustment would provide additional funds for penalty payment.
Remember to subtract this amount from company assets, as calling in the loan will remove it as a
note receivable.

Equity Valuation

Here we summarize other information gathered on company assets and liabilities to more
accurately estimate company equity.

•	Adjusted company assets. Enter the adjusted value of company assets. To
calculate this figure, subtract liquidated assets from assets as they appear on
Form 1120S, Schedule L, Item 15.

•	Estimated incremental value of undervalued assets. Enter the value on Line
15 of Section IV, Part C of this worksheet.

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•	Adjusted value of assets. Sum the figures on Lines 32 and 33 for an estimate
of the company's assets.

•	Adjusted liabilities. Enter the revised total for company liabilities from Line
17 above on Line 35.

•	Estimated adjusted equity. Subtract Line 35 from Line 34 and enter this
figure on Line 36. This is an estimate of the company's equity, based on
adjustments to assets and liabilities.

Continuing with our example company, Qever Designs Advertising, we illustrate the equity
assessment. Qever Design's assets, per its balance sheet, are $240,600; its liabilities equal $155,650,
for total equity of $84,950. Your review of the company's assets indicates that Qever Designs does
not seem to be holding any undervalued assets; however, a loan to a shareholder equalling $7,600
is outstanding. We subtract this amount from assets, as these funds can be applied to a penalty.
The adjusted asset figure equals $233,000. Also, one of the company shareholders lent the firm
$5,000 several years ago. The loan from the shareholder is effectively an equity infusion. Thus we
reduce liabilities by the loan amount. Our new equity total equals $82,350.*

Part C - Case Disposition

The final section of the worksheet summarizes your results. In your investigation, you
estimated Qever Designs' potential after-tax cash flow of $86,134 (enter this on Line 37). Also, you
determined that Qever Designs could furnish $7,600 by calling in a loan made to one of its
shareholders (enter this on Line 38). Adjustments that you made to the company's liabilities
indicate that equity in the company equals approximately $82,350 (enter this on Line 39). As a final
step, note whether the analysis of the Subchapter S corporation is completed, or will be extended
to affiliated entities.

Remember that this summary does not^nply that the company must produce funds through
the sources you have identified. Rather, your review is aimed at more accurately assessing the
resources that the entity has to call upon. Any final ability to pay figure will clearly incorporate the
judgment of the enforcement team regarding what is appropriate given the violation and original
penalty amount.

While your extended ability to pay assessment can identify sources of funds for penalty
payment, this might not happen in all cases. If extended analysis of an S corporation produces
negative results, you might want to investigate the extent of shareholder liability. If you determine
that shareholders could be responsible for corporate liabilities, you should perform a Beyond ABEL
analysis on the individual shareholders to determine the amount of funds that they could contribute
towards a penalty.

8 Assets: $240,600 - $7,600 = $233,000.
Liabilities: $155,650 - $5,000 = $150,650.
Equity: $233,000 - $150,650 = $82,350

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CORPORATION
EXTENDED ABEL ANALYSIS

Section VTL Case Disposition (continued)
Equity Valuation

31. Adjusted company assets (subtract out liquidated assets)

32. Estimated excess value of undervalued assets

33. Adjusted total assets

±

34. Adjusted liabilities

35. Estimated adjusted equity (Line 33 - Line 34)

Part C. Case Disposition

36. Violator's estimated after-tax cash flow for 19

37. - Estimated assets available for liquidation

38. Estimated adjusted equity

Part D. Final Status (check one)

Analysis completed

S

$

$

Pursuing further analysis

nalyst's Name

Date

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CORPORATION
EXTENDED ABEL ANALYSIS

Section VI. Business Expenses

Part A. Officers' Salaries

Officer

Percent time
devoted to
business

Salary

Amount of
reduction

































17. Total reductions



Summarize duties and provide justification for reductions listed above:



Part B. Other Expenses

Expenses category

Amount
expended

Possible reduction

























18. Total possible reduction in expenses



Provide justification for reductions specified above:



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CORPORATION
EXTENDED ABEL ANALYSIS

Section VII. Case Disposition

Part A. Cash Flow

19.

Taxable income (before NOL) - Form 1120, line 28



20.

Depreciation/Depletion/Amortization



21.

Pre-tax cash flow



22.

Reductions in officer's salaries



23.

Reductions in other expenses



24.

Estimated pre-tax cash flow



25.

Tax adjustment [(1 - 0.385) x Line 24]



26.

Non-cash deduction tax benefits



27.

Estimated after-tax cash flow (Line 25 + Line 26)

Part B. Equity Assessment



Asset Liquidation

28.

Value of loans to shareholders



29.

Net value of luxury or unnecessary assets



30.

Estimated funds available from liquidation

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S-CORPO RATION
EXTENDED ABEL ANALYSIS

Section VTL Case Disposition

Part A. Cash Flow

20. Taxable income - Form 1120S, line 21

21. Depreciation/Depletion/Amortization

22. Pre-tax cash flow

23. Reductions in officer's salaries

24. Reductions in other expenses

25. Estimated pre-tax cash flow

±

±

±

26. Tax adjustment (Line 24 x 0.67)

27. Non-cash deduction tax benefits

28. Estimated after-tax cash flow (Line 26 + Line 27)

±

Part B. Equity Assessment

Asset Liquidation

29. Value of loans to shareholders

+

30. Net value of luxury or unnecessary assets

31. Estimated funds available from liquidation

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S-CORPO RATION-
EXTEND ED ABEL ANALYSIS

Section VTL Case Disposition (continued)

1

Equity Valuatioa

32. Adjusted company assets (subtract out liquidated assets)

33. Estimated excess value of undervalued assets

34. Adjusted total assets

35. Adjusted liabilities

36. Estimated adjusted equity (Line 34 - Line 35)

Part C. Case Disposition

37. Violator's estimated after-tax cash flow for 19

38. Estimated assets available for liquidation

39. Estimated adjusted equity



Part D. Final Status

check one)

Analysis completed

Pursuing further analysis

Analyst's Name

Date

-------
S-CORPO RATION
EXTENDED ABEL ANALYSIS

Section IV. Business Assets (Use data from 1120S Schedule L, compare with Financial Statements)
Part A. Loans to Shareholders

Borrower

Date and
amount of
loan

Interest
rate

Amount
outstanding
(date)









































13. Total outstanding loans to shareholders



Part B. Luxury Assets

Asset and use

Estimated
market value

Balance due
on loan

Replacement
cost

Potentially
available



















































14. Total potentially available net of replacement



-------
S-CORPO RATION
EXTENDED ABEL ANALYSIS

Section IV. Business Assets (continued)

Part C. Undervalued Assets

Asset and use

Book value

Estimated
market value

Value
difference

















































15. Total estimated excess value of assets



-------
S-CORPO RATION
EXTENDED ABEL ANALYSIS

Section V. Loans from Shareholders

Lender

Date and amount
of loan

Amount outstanding
(date)

























16. Total outstanding loans



17. Revised liability total



-------
S-CORPORATION
EXTENDED ABEL ANALYSIS

Section VI. Business Expenses

Part A. Officers' Salaries

Officer

Salary

Amount of reduction

























18. Total reductions



Summarize duties and provide justification for reductions listed above:



Part B. Other Expenses

Expenses category

Amount
expended

Possible
reduction

19. Total possible reduction in expenses

Provide justification for reductions specified above:

-------
S-CORPORATION
EXTENDED ABEL ANALYSIS

Section III. Ownership and Operating Affiliations (from tax returns, Financial Statements and/or D&B
report)

Part A. Corporate Affiliates

Additional business concerns (check and answer where applicable)

Yes

No

9. Is this S-corporation affiliated with any other business concerns







10. If Yes, provide the following information:

Affiliate's Name

Type of entity

Relationship and
percentage ownership



















Part B. Shareholders and Officers

11. Shareholder and
corporate position

Percent
ownership

Dividends/
Distributions

Information regarding
shareholder affiliations

































-------
S-CORPORATION
EXTENDED ABEL ANALYSIS

12. Summary: Discuss possible expansion of ability to pay analysis, and additional
information required.

-------
SUBCHAPTER S-CORPORATION
EXTENDED ABEL ANALYSIS

Section I. Central Information

1.

Violator's name:

2.

Address:

3.

Principal business activity and product or service (1120S Schedule B Lines 2a and 2b):

4. Original penalty amount



5. As a percent of sales (penalty + 1120S line la)



Section II. Financial Information

6. Tax returns and schedules available

Year Prepared





















7. Financial Statements provided

Audited? Y or N

Period(s) covered

































-------
SUBCHAPTER S-C0RP0RAT10N
EXTENDED ABEL ANALYSIS

Section n. Financial Information (continued)

8. Other violator or general industry information collected and date of document(s):

-------
,™1120-A

o» freasi/v

U.S. Corporation Short-Form income Tax Return

Instructions are separate. See them to make sure you qualify to file Form 1120-A.
For calendar year 1991 or tax year beginning 	1991. ending 	 19 ...

0MB No 15J5-0890

HD91

A Checu tnis OO* if
cons is a se^onai
sen/ice corp 0*ntrflcation nvmoer

Other- i Numoer. Street, ana room or suite no ilf a P 0. DO*, see oage 6 of instructions.)
WtM,

C Date incorooratea

print or i ~,tv 01 ,own 5,a,# ano iip cooa
type-

D Tom assets 1 see Soecrtic instructions j

E Chec* aooucaoie oo*es. (1) L_l initial return	(2J1	! Chang# m aodress

F Checu metnoo of accounting: (1) Q Casr <2) 0 Accrual 13) 0 Other ispecrtv) ¦ >

« I

E

o
u I

C I

1a

2

3

4

5

6

7

8

9

10

11

Gross receioa or sales L

. b Less returns ana uiowinca L

:C Balance *

Cost of goods soia (see instructions! . .

Gross profit. Subtraa line 2 from line 1c ....

Domestic corporation aiviQenas subiect to tne 70% deduction

interest ... 		...

Gross rents. . 	

Gross royalties 		...

Caoitai gain net income (attacn Schedule 0 (Form 1120)) .

Net gain or nossi from Form 4797. Part II. line 18 (attacn Form 4797)

Other income isee instructions!.

Total income. Add Imea 3 througn iQ		

1c

2 I

I 9

10

11

i

= S
• 3

21

(A

e
o

o
3

•o

« I

Q I

; 12

13a

14

15

16

17

18

19

20

21

22

23

24

Compensation of officers isee instructions)
Saianes and wages I	^

I 12

b Less iods credit

C Balance * 1

20 !

I 21

a i

25

26

27

28

¦a i

C I
0) I

Ej
>
n

a. I

¦o I
c :
n i

X I

n l

Peoairs	...

Bad deots	

Rents 	

Taxes		

interest		

ContnPutions (>M instructions for 10% limitation)

Deoreciation (attacn Form 4562)

Less depreciation claimed elsewhere on return

Other deductions (attacn schedule)

Total deductions. Add lines 12 througn 22

'axaoie income oelore net operating loss aeouction ana soeaai aeductions Subtract nne 23 Irom line 11

Less: a Net operating loss deduction isee mstructionsi
b Special deductions isee instructions!

Taxable income. Subtraa line 25c from nne 24
Total tax ifrom page 2. Part I. line 7)

Payments:	.

1990 overpayment credited to 1991 I 28a '	

14

15

16

17

18

19

22

23

24 I

1991 estimated tax payments

r

28b

29

30

31

32

less 1991 retuno ICB"M (or on form 4466 I 28c i>	¦

Tax aeposited with Form 7004 . .	...

Creait from regulated investment comoanies lattacn Form 2439) .

Credit for Federal tax on fuels (attach Form 4136) See instructions
Total payments. Add lines 2Bd througn 28g	. .

Estimated tax penalty (see page 4 of mstructionsi. ChecK if Form 2220 is attached
Tax due. if the total of lines 27 and 29 is larger than ime 28h. enter amount owed . . .
Overpayment, if line 28h is larger than me total of lines 27 and 29 enter amount overpaid .
E"!er amount of line 31 vou want Creditefl to 1992 estimitefl In ~	i Refunded ~

32 I

l Uncar DWian>«t of	i a*ci*r« mat 1 rava aiaminao tnn '«lum >nciuo>nq accompanying scnaculaa ana stat*rn«nti ana 10 '*"• Mtl of my knowwcga ana

PleaS© I :enaf it U inja correct, ana comoKtt Declaration of oraoarar iom«r tnan tajoayari n MHO on ail information of wnicn oraoarar nai any knowwoq*

Sign
Here

S.qnaiure of o<*icer

Date

>

Pp«ar©f 3 k
Signature ~

Paid

Preparer s i F.rnvs name >or vours
Use Only 1 ' serf-«fnoioyeai ana

Date

Checu rf
' sert-«fnoioveo

Preoa/er s social secuntv numoer

El No ~

ZIP coae ~

For Paperwork Reduction Act Notice, see page 1 of the instructions.

Cat. No 11456E

"01m 1120-A . 13911

-------
:orrr> 1 'Jt-A (iqqn

Tax Computation

1 income tax isee instructions to figure tne taxi. ChecK tnis Do* if tne corn, is a auantiea Dersonai service

corp. (see instructions! ...			. . . ~ G

2a General Dusmess creait Check if frorrv form 3800 !_ form 3468 L_ form 5884 I

~ Form 6478 ~ Form 6765 G forrr 6586 G Form 8830 G form 8826 I 23 1	'

b Creait for orior vear minimum tax (attacn Form 88271	2^ 1

3	Total credits. Add lines 2a ana 2b	.... . . .

4	Subtract line 3 from line 1 . . . . 	

5	Recapture taxes. Check if from: G Form 4255 G Form 8611
8	Alternative minimum tax (attacn Form 4626). See instructions
7	Total tax. Ago lines * through 6. Enter nere ano on line 27. page 1

Part II

5 I

Other Information (See page 15 of the instructions.)

1

Refer to tne list in tne instructions ana state tne onncioai:

a 8usmess activity code no. ~	

b Business activity ~	

c Product or service ~ 	

Did any individual, partnership, estate, or trust at tne end of the
tax year own. airectty or inoirectty. 50% or more of tne
corporation s voting stocK? (For ruies of attnbution see section
267(c).) .			G Yes G No

if "Yes." attacn scneauie snowing name, aoaress. ana identifying
-lumoer

Enter tne amount of tax-exempt interest received or accrued
dunng tne tax year	~ L§	i	

if an amount is entered on line 2. page i. see tne worxsneet on oage
11 for amounts to enter betow:		

(1)	Purcnases (see instructions) . .

(2)	Additional sec. 263A costs isee
instructions—attacn scneouiei
Other costs (attacn schedule)

Enter amount of casn distnbulions ano the dook value of prop-
erty (other man casn) distnbutions made n tnis tax
vear •	.... ~ 1 $	i

(3)

Do the rules of section 263A (for property produced or acquires for
resalel apply to the corporation? ... . . G Yes G No
At any time dunng tne tax year, did the corporation nave an interest in or
a signature or other autnonty over a financial account in a foreign courw
sucn as a oank account, securities account, or otner financial accou-: >
¦See page 15 of the instructions for filing requirements lor Pom
TDF 90-22.1.)	G Yes G No

t

if *Yes." enter tne name of the foreign country ~ 		

Part III

Balance Sheets

(a) Beginning of tax vear

(bl Eno at tax v»ar

(/)
(/»
<

1	Cash	

2a	Trade notes and accounts receivable

b	Less allowance for bad deots

3	invemones .

4	US government obligations

5	Tax-exemot secunties (see mstructionsi

6	Other current assets (attacn scneouiei .

7	Loans to stockholders

8	Mortgage ano real estate loans

9a	OeoreciaDle. aeoietabie. and mtangiDie assets

b	Less accumulated ceoreciation. ceoietion. ano amortization

10	Land (net of any amortization) .

11	Otner assets lattacn scneouiei	. . .

12	Totai assets .	.	..	

13

14

¦O ffl
C UJ I

™ . .

-------
fjffTfSfflBWB Tax Computation

n

T2

CnecK it vou are a memoer 01 a cor.troneo crouD isee secvcrs "o5i ara 1563'
it trie oo* on nne 1 is cnecxea

Enter your snare ot tne $50,000 ana S25 000 taxable income oracxet amounts nn tnat oroeri

(I) !i		 (ii) Li	

Enter your snare of tne additional 5% tax inot to exceed Si l.750i	~ !i	

4b

4c

3 income tax isee instructions to figure tne taxi Cnec* tnis dox if tne corooranon is a auanfiea oersonai service

corooration isee instructions on cage 13)	~ 	

4a Foreign tax creait lattacn Form 1118)	*a	

6 Possessions tax creon lattacn Form 5735)
c Oronan arug creait lattacn Form 6765).

d Creait tor tuei oroaucea from a nonconventionai source isee instructions)

e General Ousmess creait. Enter nere ana cnec* wnicn forms are attacnea

	 Form 380C 	 Form 3463 	 Form 588- — Form 647S

	i Form 6765 _j Form 8586 _J Form 8830 	 Form 8826

t Creait for onor year minimum tax lattacn Form 8827)

4d

4f

5 Total. Aoa nnes 4a tnrougn 4t

6	Suotract nne ; trom line 3

7	Personal noiamo comoanv tax lattacn Scneauie °h iForrr • :2Z

8	Recapture taxes Cnecx it from 	 Form 42 = 5 	 Fern 36".'

9a	Alternative minimum tax lattacn Form 4626; See instructions

b	Environmental ta» lattacn Form 4626)

9a

i 9b

10 Total tax. Ago nnes 6 tnrougn 9o Enter nere ano on nne 3i oaoe i	

Other Information (See page 15 of the instructions.)

10

1	Cnecx metnoa of accounting

a	C Cash

b		; Accrual

c		! Otner isDecify) ~ 	 ... .

2	Refer to tne nst in tne instructions ana state tne ormcioai
a	Business activitv cooe no *¦ 	

b	Business activity ~	

c	P'oauct or service ~	

3	D^o tne corooranon at tne ena of tne tax vear own
oi'ectiv or mairectiv 50c/o or more of tne voting stock
ot a comesuc coloration7 iFor ruies of attriDution see
section 267(C))

if 'Yes ' attacn a scneauie snowing iai name aaaress
ana loentitvmg numoer loi oercentage owneo ana ici
taxaDie income or uossi oetore NOL ana special
oeauctions or sucn corooration rc tne tax year enamg
witn or witnin vour tax year

4	Dia anv inaiviauai oannersnio corooration estate or
trust at tne enc Of tne tax vear own airectiv or mairectl\
50% or more of tne corooration s voting stock7 iFc
ruies ot attribution, see section 267(c) i i' "Yes
comoieie a ana b

a Attacn a scneauie snowing name aaaress. ana

laentifying numoer
b Enter percentage owned > 	

5	DiO one foreign Derson isee instructions for aefinitioni
at anv time curing tne tax vear own at least 25% 0"

a Jne total voting Dower of an Classes of stocx of tne

corooration enntieo to vote, or
D Tne totai vaiue ot an Classes ot stocx of tne corooration">
'¦ v,s tne corooration mav nave to tne Form 5472

i* "Yes. enter owner s countrvnesi ~ ... 	

E-'e' n.moe'd' For-.s S-72 artacneo ~

11

12

Was tne corooration a U.S sharenoider of any contronea
foreign corooration'' (See sections 951 and 957 )
if "Yes." attacn Form 5471 for eacn sucn corporation
Enter numoer of Forms 5471 attacned ~	

At anv time ounng tne tax year, did the corporation nave
an interest m or a signature or otner autnoritv over a
financial account m a foreign country isucn as a oan>
account, securities account, or otner financial account:''
(See cage 15 of tne instructions for more information
including fmng reauirements for Form TD F 90-22 1
" "Yes ' enter name of foreign country ~	

Was tne corooration tne grantor of. or transferor to. 2
foreign -trust tnat existed during tne current tax year
whether or not tne corporation nas any oeneficiai interest '
m if	. . • . ...

if "Yes " tne corporation may nave to file Forms 352C
3520-A. or 926

During tnis tax vear did the corporation oav dividencs
lotner tnan stocK aiviaenos ana distnoutions in excnange
•or stocKi m excess of the corporation s current anc
accumulated earnings and profits? (See sections 301 anc

3161		

if "Yes." file Form 5452 If this is a consolidated returr
answer nere for oarent corporation ano on Form 851.
Affiliations Scneauie. for each subsidiary.

Cneck tnis oox if the corooration issued ouoiiciv offeree

aeot instruments witn original issue discount ~ 	

if so. tne corooration mav nave to fne Form 828"

Enter tne amount of tax-exemot interest receives :
accrued during tne tax year ~ 	



if tnere were 35 or tewer'snarenoioers at tne ere o'
:ax vear er:e' tne numper ~

Yew No

m



P



''A

¦//'/

-------
Schedule L

Balance Sheets

segmnno or "ax .ear

;~o ot 'a* vear

1

23

3

3

4

5
S

8

9

iOa
b
11a

b

12
13a
b

14
i5_

16

17

18

19

20

21

22

23

24

25
26'
27

Assets

Zasn

" ace nctes ana accounts receivaoie ,
..ess anowance tor oad oeots
r.eniories

_ S government ooiigations
~2x-exemot securities isee msinjct;onsi
C:ner current assets ianacn scneauiei
usans :c stocKnoiaers
Vortgage ana reai estate loans
2:rer investments ianacn scneauiei
cjnamcs ana otner aeoreaaoie assets
Less accumulated aeoreciation
ZeoietaDie assets
Less accumuiateo aeowtion
_ana met of anv amortization!
rtangioie assets lamortizaoie oniyi
Less accumuiatea amortization
Itner assets .attacn scneauiei ,

~:tai assets

Liabilities and Stockholders' Equity

-ccourts oavaoie

"encages 'res CC'CS cavaDie i" 'ess :r.an ' .ear
Itner c_rrent naDinties lattacn scneauiei
_;ans trom stocunoiaers
'Mortgages, notes ocnas cavaoie m i .ear or more
"'Cther naouities ianacn scneauiei
Caonai stoc.K a Preferrea stock
b Common siock
?aia-in or caoitai suroius
=e;ainec earn.-cs—-ooroor.atea iatta:r, scrteouiei
=etamea earnings—•Jnaoorooriatea
.ess cost of treasury siock
~:tai nacnit.es ana stocKnoicers' eauitv

Reconci.iation of Income per Books With Income per Return iThis scneauie aoes
zomoietea 
-------
Schedule L

Balance Sheets

Beginning or tax vear

Ena of tax vear

Assets

>Casn

i	Traae notes and accounts receivable

b	Less allowance for bad debts

j'	mventones

4	US Government obligations

5	Tax-exempt securities ,

6	Otner current assets Iattach scneauiei

7	Loans to snarenolders

8	Mortgage and real estate loans .

9	Other investments (attach scnedule)
10a	Buiiaings and otner depreciable assets

b	Less accumulated depreciation

11a	Depietable assets . .

b	Less accumulated depletion

2	Land (net of any amortization)

3a	intangible assets (amortizabie only)

b	Less accumulated amortization

4	Other assets (attach scnedule)

5	Total assets

Liabilities and Shareholders' Equity

6	Accounts payable

7	Mortgages notes Donas oayaote m less tnan 1 vear

8	Other current liabilities lattach scnedule)

9	Loans from shareholders .

20	Mortgages notes bands payable in 1 year or more

111	Other liabilities (attach schedule)

K	Capital stock		

23	Paid-m or capital surplus .

24	Retained earnings . .

25	Less cost of treasufy stock , .

26	Total liabilities and shareholders' eauitv

Schedule M-1

Reconciliation of Income per Books With Income per Return (You are not required to complete
this schedule if the total assets on line 15. column (d). of Schedule L are less than $25,000.)

1	Net income per books

2	income included on Schedule K. lines 1
tnrough 6. not recorded on oooks this year

(itemize)' 	



5 Income recorded on books this year not
included on Schedule K. lines 1 through
6 (itemize):

a Tax-exempt interest $ 	







3 ^Expenses recoraed on books this year not
included on Schedule K, lines 1 through
11a. iSe. and 16a (itemize):
a Depreciation $ 	



6 Deductions included on Schedule K. lines
. 1 through 11a, 15e. and 16a. not charged
against book income this year (itemize):
a Depreciation $ 	



b Travel ana entertainment $









7	Add lines 5 and 6	

8	income (loss) (Schedule K. line 20). Line 4 less hne 7



4 Add lines 1 through 3 i



Schedule M-2

Analysis of Accumulated Adjustments Account, Other Adjustments Account, and
Shareholders' Undistributed Taxable Income Previously Taxed (See instructions.)

(c) Sharenoeers unaistnDutee
taxatte income txevousry taxed

1	Balance at oeginning of tax year

2	Ordinary income from page 1. line 21

3	Other additions

4	Loss from page 1. line 21

5	Other reauctions

6	Combine lines 1 through 5

7	Distrioutions otn'v tnan oiviaena aistrioutions

8	8'isnce at entf oi tax vear SuOtract m 1 from line 6

• U.S. S»-19912tS-2?i

-------
¦::s --99'

Schedule K

Shareholders' Shares of Income. Credits, Deductions, etc.

(a) Pro rata share items

(b) Total amount

1	Ordinary income dossi from trade or ousiness activities (page i, line 21]

2	Net income ^tassi from rental real estate activities (attach Form 8325).
3a Gross income from other rental activities	, .	3a 1

3b


o

©
E
o

V

c

b Less expanses (attacn scnaaule). 	

c Net income (loss! from otner rental activities	 ....

4	Portfolio income (loss):

a Interest income .		 ....

b Dividend income.	'		

c Royalty income ....		

d Net snort-term capita) gain (loss) (attacn Schedule D (Form 1120S))	

e Net long-term capital gain (lossi (attacn Schedule D (Form 1120S)). ...
f Other portfolio income (loss) (attach schedule) .....

5	Net gain (loss) under section 1231 (other than due to casualty or theft) (attach Form 4797)

6	Other income I loss) (attach schedule)	.	. ...

4d

4f

3

¦o

<3

7	Charitable contnbutions (see instructions) (attach Irst)	

8	Section 179 expense deduction (attach Form 4562).	

9	Deductions related to portfolio income (loss) (see instructions) (itemize)
10	Other aeductions Iattach schedule)

10

u -5

E S

11a interest expense on investment debts . 	

b (1) Investment income included on lines 4a through 4f above
(2) Investment expenses included on line 9 above

11a

ilbmL

"wai

¦o
o

12a Credit for alcohol used as a fuel (attach Form 6478)	

b Low-mcome housing credit (sae instructions):

(1)	From partnerships to which section 42(j)(5) applies for properly placed in service before 1990

(2)	Other than on line i2b(1) for property placed m service before 1990	

(3)	From partnerships to which section 42(j)(5) applies for property placed in service after 1989

(4)	Other than on line I2b(3) for property placed m service after 1989 		

c Qualified rehabilitation expenditures related to rental real estate activities (attach Form 3468)

d Credits (other than credits snown on lines 12b and 12c) related to rental real estate activities

(see instructions)		

e Credits related to other rental activities (see instructions)	

13. Other credits (see instructions)			

12a

12b<2>

12X3)

M

12c

12d

12e

13

ro	—

-2	

£	S

u

<

14a Accelerated depreciation of real property placed in service before 1987 . .
b Accelerated depreciation of leased personal property placed in service before 1987

c Depreciation adjustment on property placed in service after 1986 	

d Depletion (other than oil and gas)			...

e (1) Gross income from oil, gas. or geothermal properties	...

(2) Deductions allocable to oil. gas. or geothermal properties	

f Other adjustments and tax preference items (attach schedule) . . . .

14b

14c

14d

mm



14f I

2

c

?
5

115a Type of income ~	 	

|	b Name of foreign country or U.S. possession ~ 	

1	c Total gross income from sources outside the United States (attach schedule)

| d Total applicable deductions and losses /attach schedule)	

I e Total foreign taxes (check one): ~ G Paid O Accrued	

' f Reduction in taxes available for credit (attach schedule)	

* g Other foreign tax information (attach schedule)		. .

15c

15d

1Se l

15f

JSg_

V
£

o

16a Total expenditures to which a section 59(e) election may apply	

i b Type of expenditures ~ 		

! 17 Total property distnbutions (including cash) other than dividends reported on nne 19 below

18	Other items and amounts required to be reported separately to shareholders (see
instructions) (attach schedule)

19	Total dividend distnbutions paid from accumulated earnings and profits	

20	Income (losa) (Required only if Schedule M-1 must be completed.). Combine lines 1
througn 6 m column (b). From the result. suPtract the sum of lines 7 througn 11 a. 15e. and

16a		

16a i

-------
- 1 \£X)

c» •-« "••a»ury

=or caienaar vear 1991 or tax vear Beginning 	"991. enoing 	 "9

~ Instructions are seoarate. See oage 1 for Paoerwor* Reduction Act Notice.

HI91

a Ci^ec* it a—

' Carsonaaieo 'e:urn 	

anacn rcr-n s5it 	

2' oe-jonaj noioma :e —

anacn Sc" -M' 		

?ewai service :::s
as aenneo « "e-o
=•« sec ' —
•.W ¦rs:r-.c'.:-si

Uh Name
IRS

B Employer identification number

Other- 1 Numoer sueei ana room or suite no nt a P 0 so* see oaqe 6 o» -rsirvictions )
wise.

C Date incorporated

print ori c,tv °r ,own slale ano ^lP coce
type.

0 Total assets isee Soeofic instruct!ortji

s 1

E Chec« acoiicao'e "co»es '1 '	 '.-it'ai return 2* 1	 r-at return 31 1	: ;>anoe m aoaress

ia

2

3

4

5

6

7

8

9

10

11

j :ss receiots or saies l

. b Less returns ana allowances l.

c Bai ~ ' 1c

Cost ot gooos soia [Scheauie a ime r)

Gross orotit Subtract line 2 from ime lc

C.viaenas iScheauie C. l.ne 19)

rterest

Gross rents

jross royalties

Caoitargain net income lattacn Scheauie 0 (Form M201)

'Jet gam or nossi from Form 4797 Part ii. ime 18 lattacn Form 4797)

C:her income isee instructions—attacn scneouiei

Total income. Aaa lines 3 throuon 10

2 I

3 I

4 l

5 I

I 7

8 I

9 I

10

11 i

b Less iocs creait

e Baiance ~ 13c

¦3
a>
¦3

o

j\

e

0

%

1

o

20 I

¦3

¦J

O

12	Compensation of officers iScneouie £, me 4i

13a	£ jianes ana wages i	

14	=eoairs

15	3aa ceots

16	=ents

17	"axes

18	rterest

19	Contnoutions Ism instructions for 10% limitation I

20	Depreciation lattacn" Form 4562)

21	.ess aeoreciation ciaimea cn Scheauie a ana eisewnere on return

22	Deoietion

23	iavertising

24	= 1990 overoavment creoneo to 1991 i 32a 1
•991 esumatea tax oaymems

30 i

32b i

.ess '991 'eruno aoonea for on Form 4466 ' 32c '	

~i* aeoosnea witn Form 7004

Creait 'rom reguiatea investment comoames iattach Form 2439)

C.-eon for Feaerai tax on fueis lattacn Form 4i 36). See instructions
rstimatea tax oenaitv isee cage 4 of instructions! ChecK if Form 2220 is attacnea
Tax due. if *ne total of lines 31 ana 33 is larger man nne 32h enter amount owea
Overpayment, if ime 32h is larger tnan trie total of lines 31 ana 33 enter amount overpaia

34 1

35

:^;er amount ot ime 35 vou want Credited to 1992 estimated tax ~

. Refunded ~

36

Please

Sign

Here

^rcer ceratues oj zenuty recare '^ai i "a.e e*an-.inec :nis 'e'um .ncvo^o acczmosnvinq sc'ecuies a*o	jo rre oesi -*^v «nowieooe

••a sene' -t s carrier ara rsmciete Cec aranon ot o'eoaref 'Oiref iran ta*oavefi is caseo on a i imofmanon 01 *nicr srecaref *as anv ¦no*ieoce

~

S ^rature c c" cef

~

~

= -?carer 5

Paid	i ^rature

Preparer s z 5 ".a^e ior
Use Only • * se''-emo'-v^oioveo l— .

:-z access

~

E I NO ~

; p coae ~

No ' -SCO

-------
*'?0 ¦1991

Schedule A

-2se 2

Cost of Goods Sold (See instructions

4a

4b

I 5

1	inventory at beginning of vear

2	Purcnases

3	Cost of laoor	. .

4a Additional section 263A costs isee instructions—attacn scneauiei
b Otner costs lattacn scnedule)

5	Total. Add lines 1 tnrougn 4b .	.....

6	inventory at ena of year . .	...	...	.... 1 8 i

7	Cost of goods sold. Subtract line 6 from nne : Enter nere ana on ime 2. oage 1	7 '	

8a Cneck all metnoas used for valuing ciosmg inventory

(i) Cost	(ii| D Lower of cost or market as described in Regulations section 1 471-4 isee instructions)

(in) _| Wnteoown of suonormai" goods as aescrioed m Regulations section i 471 -2lc) isee instructions!

(iv) 		I Otner (Specify metnod used and attach explanation i ~ 	

b CnecK if tne LlFO inventory memoo was aaootea tnis tax vear tor any goods (if cnecxea, attach Form 970)
c if tne LlFO inventory method was used for this tax year, enter percentage (or amounts) of closing ! j

inventory comDuted under LlFO		1 Ac I	

d Do tne ruies of section 263A (tor DroDerty produced or acauired for resale) apoiy to tne corporation''	. .

Was mere any cnange in determining Quantities cost, or valuations between opening ana ciosmg inventory'' If "Yes." 	

attacn explanation	!	!

Yes 	! No

Yes	No

Schedule C

Dividends and Special Deductions (See instructions.)

(a) Diviaenos
'ecetvec

(b) %

l(cl

Soeoai oeajcno"s

(a) ' (bi

8

9

10

11

12

13

14

15

16

17

18

19

Dividends trom iess-tnan-20%-owned oomestic corporations tnat are suoiect to tne
70% deduction (otner tnan oeot-fmancea stocxi

Diviaenas from 20%-or-more-owned domestic corooranons tnat are suoiect to tne
80% oeduction (otner tnan oeot-tmancea stocki

Diviaenas on aebt-fmancea stock of oomestic ana toreign corporations (section 246a:
Diviaenas on certain preferred stock of iess-tnan-20%-ownea ouphc utilities
Dividends on certain preferred stocK of 20%-or-more-ownea puDtic utilities
Dividends from iess-tnan-20%-owned foreign corporations ana certain FSCs that are
suoiect to tne 70% aeduction

Dividends from 20%-or-more-owned foreign corporations ana certain FSCs that are
suoiect to tne 80% aeauction

Divioenos irom wnoiiy ownec iorngr suDS.oiares suaec: -o '"e iOC:/j oeovcron isecnon 245(C)'
Total. Ada lines 1 tnrouon 8 See instructions for limitation

Diviaenas from oomestic corporations received dv a smaii ousiness investment
companv ooeratmg unoer tne Smaii Business investment Act of 1958
Diviaenas trom certain FSCs tnat are suoiect to tne 100% aeauction isecnon 245ic)C ..
Diviaenas trom artiliateo group memoers suoiect to tne 100% aeauction isecnon 243(aH3)>
Otner oividends from foreign corporations not included on lines 3 5 7. 8. or 11
income trom controlled foreign corporations unoer suooart F lattach Forms 5471)
Foreign oivioena arcss-uo isecnon 78)

1C-D1SC ana former DISC diviaenas not mciuaea on nnes l 2 or 3 (section 246(a))
Otne.- appends

Deaucnon tor aiviaenos paid on certain oreterred stocK of oudiic utilities isee mstruaions
Total dividends. Aaa lines 1 tnrougn 17 Enter nere ana on nne i. page i ¦ ~

20 Total deductions. Add lines 9 10 11

12 ana 18 Enter nere and on ime 29b oaae

70

8C

555"

lP>»tructions

41 176

47.059

70

80

100

100

100

Compensation of Officers iSee instructions for line 12. page 1.)

Complete Scneauie E orw it forai receiots lime la dius lines 4 tnrougn 10 of page 1 Form 1120) are SS00.000 or more



|e) Percent ot .

o' coroonno"
six* iw»:

(f) Amount oi comoensanc"



(al Name oi ortice' Kb) Sociai security numoeri time oevoteo to ~

susines: 1

(d) Common

1 (#) Pretetrea

1

%

%

% .





% '

%

1 % '





:*o

%

% '





%

%

%







%

%



2

Totai comoensanon ot officers







3

Less: Comoensanon of officers oaimea on Scneauie a ana e'se«nere on returr



(



A

Comoensanon ot cnicers oeaucteo on .me *2 oaae







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SCHEDULE K-1
(Form 1120S)

-eo*nme<->t or ~e •

-iemai Severe ae^ic®

Shareholder's Share of Income. Credits. Deductions, etc.

~ See separate instructions.

;MB No :-5-0'.2C

For calendar year 1991 or tax year
beginning 	. 1991. and ending

19

11191

Shareholder's identifying number ~

Corporation's identifying number ~

5harenoicer s iame. aaaress. ana ZIP coae

Corporation's name, aaaress. ana ZIP coae

A Snarenoiaer s oercentage or siock ownersnip for tax year isee instructions for Scheaule K-1)	~ 	 -?

B Internal Revenue service center wnere corporation filed its return ~ 	

C (1) :ax sneiter registration numDer (see instructions for Scheaule K-1)	~ 	

(2) T/be of tax sneiter ~ 		.	

~ C^ecK aooticaple Poxes: (1) T Pinal K-1 (2) P Amenaed K-1			

' (c| Form 1040 tilers enter
; :ne amount in coiumn ioi on:

(a) Pro rata snare items

(b) Amount

¦j) i
n i
O l

a*

E
o
u
c

1	Ordinary income (lossi from trade or ousmess activities

2	Net income (loss) from rental real estate activities

3	*iet income Hossi rrom otner rental activities
¦i	Portfolio income Hossi

a	irterest

b	Oiviaenas

c	Royalties

d	Net snort-term capital gam Hossi

e	Net long-term capital gain Hossi

f	Other portfolio income (ioss;  '

2	ij b (1) '"vestment income mciuaed on noes Ja tnrouan 4f above
= 	(2) investment expenses mciudeq on nne 9 aoove	

11a I

b(1)l

b(2) I

Form 4952. line 1

I See Snarenoiaer s rs:ruc;ions
[ 'or Scneauie KH :orm H2CS)

b(1) I

b(2) I

b(3) I

¦o

0)

w

o

12a C-eau'or aiconoi usea as ruei	v/m/A

b Low-income nousmg creait:

(1)	:-:~i section 42h)i5i cannersnios tor arccenv :iacea m service oeiore 1990

(2)	C'~er tnan on nne 126(1) tor oroscTy Diacea m sen/tee oetore 1990

(3)	:;:"i section 42fil(5i oannersnios (or orooertv Diacea m service aner 1989.

(4)	Gtner tnan on i:ne 120(3) lor orooertv oiacea m service after 1989
c Qualified rehabilitation expenaitures related tp rental real estate

activities (see instructions;
d C.-eaits (otner than credits shown on nnes 12b ana 12c) related

;o rental real estate activities isee 'nstructions)	j

e Creaits reiatea tot otner rental activities (see instructions) . ^2» I
13 D'.^er credits (see'nstructionsi	. : 13 I

' 12c!

12d I

Form 6478. ime'iO

( Form 8586. line 5

See Sharenoiaers --sirucnors
* 'or Sc^ecuie ::r,n!'2CS:

s s:
m —•

2 S!

s e'

u 09 i

M	I

2! 14a -ccsierated aeoreoation or reai orooertv oiacea in service oerore 1987
c:

b Acceieratea depreciation of leasea personal orooerry piacea

n service oeiore 1987
c Deoreciation adiustment on oroperty oiacea m sen/ice arter 1986
d Ceoienon (other tnan oil ana gasi
e (1) Gross income trom on. gas. or.geotnermai properties1

(2) Ceaucticns aiipcaote to oil. gas. or geotnermai orooenies
f Other aaiustments ana tax preference 'terns tartacn scnedule)

14a i

14b I

14c i

; 14d I

edn

e(2)l

14*

See Sharenoicer's
Instructions tor
) Scneauie K-' Form
1120SI ana
Instruct.ons 'cr
Form 6251

cor Paperwork Reduction Act Notice, so* page 1 of instructions for Form 1120S.

No

S2GD

Scheaule K-1 (Form 1120S) 1991

-------
^-KL'e c-"~ '""'Si 'rS11 ;i-e ^

(a) Pro rata snare items (b| Amount 'c' ^crT_! "ers er-e* .re

amount in column 'Ci on

(rt i 15a Type of income ~ ... 	 |||p i

k I b Name of foreign country or U.S. possession ~ 	 flaw, i

t- i r Tntal rjrn« inrnmn fmm en,|rr«5 nnr^rla mo 11 

£
4>
Q.

a

3

05

I

I

"U S. Govwnmgnt P-mtnq Qmca- 199'— ;ji-«

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PARTNERSHIPS

CHAPTER 5

INTRODUCTION

A partnership is a business entity owned by individuals, other partnerships, or other
businesses. Partnerships are not subject to federal income tax; rather, the income from the
partnership is passed on to the partners, who individually pay taxes on their portion. In fact, many
business organizations that opt to form as a partnership (or sole proprietorship) do so to avoid
double taxation (i.e., paying taxes on both the business income and the income passed on to the
owners). Although the partnership itself does not pay taxes, the partnership must submit a Federal
Income Tax Form 1065 return detailing the entity's income and expenses, its partners, and the share
of income passed on to each partner. The Form 1065 return should include a Schedule K-l for each
partner, specifying the share of income the partner received, and a Schedule of Activities for that
partner.1

There are two types of partnerships: general and limited. A general partnership member
is not limited in its liability (that is, its responsibility) for company debts. All general partners,
regardless of their investment or activity in the company, have total liability. Therefore, an ability
to pay analysis of a general partnership should extend beyond the company to the financial position
of the general partners themselves.

1 See the Federal Income Tax Return form 1065 sample at the end of this chapter. Note that
partnerships responding "Yes" to Item N on page 1 of the Form 1065 are not required to complete
Schedules L and M, Item F on page 1 of the 1065, or Item K on Schedule K-l. Consult the
Instruction booklet for Form 1065 for a description of partnerships not subject to this reporting.

5-1

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A limited partnership is usually comprised of both general and limited partners. General
partners have unlimited liability, while limited partners are responsible only up to the amount of
their contributed capital. An investigation of a limited partnership's ability to pay would consider
both the resources of the partnership and the resources of the general partner(s).2

Because general partners are personally liable for the financial responsibilities of the firm
they sometimes own only a small percentage of the business. Liabilities or penalties can then
sometimes be absorbed almost entirely by the limited partners. For example, let's say that three
individuals form a partnership - the two limited partners each contribute $25,000 in capital, and
each holds 49 percent of the partnership, while the general partner holds two percent. The general
partner runs the business and is paid a, salary; the limited partners receive income based on the
earnings of the business. Assume that the business fails and the partners are liable for its debts,
which total $40,000. Each of the limited partners would be responsible for 49 percent of this
amount ($19,600 each), while the general partner would only be responsible for two percent ($800).

If, however, liabilities are larger than total contributed capital in the partners' accounts, the
general partner is required to produce funds from his or her personal resources. For example, if
total liabilities equal $100,000, each limited partner is responsible to the extent of his or her total
investment in the firm ($25,000 each), and the general partner is liable for the remaining $50,000,
even though this amount exceeds his or her capital contribution to the partnership.

Before proceeding with the rest of this chapter, be certain to read Chapter 2, as it contains
important information about the worksheets.

Section I - General Information

The first section of the worksheet summarizes basic information about the violator (in this
case, the partnership) and information that has been collected thus far:

•	Violator's name. On Line 1, enter the name of the partnership.

•	Address. On Line 2, enter the violator's address.

2 Many of the partnership ability to pay cases may involve real estate or land development
concerns. On a financial statement, real estate investments often appear to be losing money,
because non-cash expenses, such as depreciation and amortization, can be deducted from the
property's revenues. In the early stages of such a concern, revenues may be minimal and the
partnership will report a loss. These "paper" losses are then passed on to the partners, reducing
their taxable income. Ultimately the partners often recognize financial gains through the sale of the
property. However, beicause a real estate partnership, might not generate cash flow (unless property
is sold) an ABEL analysis will often indicate that the entity is unable to pay. Therefore, in
conducting an ability to pay assessment for real estate partnerships, you must pay particular
attention to the difference between book and market values for property, and to any non-cash
expenditures. We will highlight these factors on the partnership worksheets.

5-2

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•	Type of partnership. On Line 3, check whether this is a limited or general
partnership.

•	Principal business activity and product or service. On Line 4, enter the
violator's principal business activity, along with its product or service.3 This
information can be found on the Partnership Income Tax return Form 1065,
Items A and B of the first page.4

•	Original penalty amount Note on Line 5 the original penalty amount
proposed.

•	Penalty as a percent of income. Divide the original penalty amount by the
entity's total income (Line 8 on page 1 of Form 1065). Note the result on
Line 6.

Section II - Financial Information

In this section of the worksheet we summarize the financial information available.

•	Tax forms and schedules available. On Line 7, enter the tax forms and
schedules supplied, along with the year of the return. Note also whether any
tax information is missing.

•	Financial Statements provided. On Line 8, list each available financial
statement (e.g., Balance Sheets, Income Statements and notes). Is this an
audited statement? Note the period covered by the statement, particularly
if the statement covers only a portion of the fiscal year. Also note whether
any necessary or useful information is missing.

•	Other violator or general industry information collected. On Line 9, list any
other material you have obtained and/or researched. Examples include the
partnership agreement, Dun & Bradstreet reports, a company prospectus,
loan applications, etc. Note as well the period covered by the document.

3	You may want to consult a financial analyst if the partnership is an agricultural operation, as
these businesses can be difficult to analyze.

4	Throughout these worksheets, we reference Line items on the 1991 version of Form 1065. The
location of items may differ for previous years' forms.

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Section HI - Ownership and Operating Affiliations

Part A - Partner Information

This section of the worksheet asks for detailed information on each of the partners," as well
as information about whether the violator itself is a partner in another partnership. This information
is particularly important, as it will indicate the extent to which the ability to pay analysis will extend
beyond the violator itself. Complete the following information for each of the general partners.5

•	General partner. Enter the name of the general partner.

•	"type of entity. Note whether this partner is an individual, partnership, or
corporation.

•	Percent ownership. Schedule K-l, Item F specifies the partner's share in the
business.

•	Guaranteed payments to partner. Line 10 of the Form 1065 and Line 5 of
each partner's K-l note guaranteed payments. These payments are for
services (e.g., if a partner earns a salary) or for the use of capital. Note on
the worksheet whether the partner has received any guaranteed payments.

Part B - Other Partnerships

Here we investigate whether the violator is a partner in any other partnerships. This
information is provided on Form 1065, Schedule B, Question 3.

•	Is the violator a partner in any other partnerships? Check yes or no.

•	Name of partnership. Note here the name of the partnership in which the
violator is a partner.

•	Principal business activity. If available, note here information about this
partnership's business activities and/or products.

•	Information required for further analysis. A detailed analysis of this
partnership may be required in the event that the violator is unable to
produce fiinds for a penalty. Note here the information that would be
required to investigate this related partnership.

5 Copy this page of the worksheet if additional information blocks are needed.

5-4

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Section IV - Business Assets

[n this section of the worksheet, we review the partnership's assets and investigate their use
and worth. Our aim is to discover whether the company is holding luxury or unnecessary assets, or
is undervaluing its assets and thereby understating its equity. As stated in Chapter 2, luxury assets
might include luxury or unnecessary vehicles, boats, planes, rental property, or other assets not
necessaty to the company's operations.

This review will focus on the partnership's more valuable assets, generally those valued at
more than $5,000. Request that the partnership provide a list specifying both the book and the
market value of these assets, as well as their business use. The latter information is important for
determining whether each asset is essential to company operations. Review the list that you receive
carefully. Do the market values seem reasonable? The worth of valuable assets should be double
checked against outside sources. Vehicle values are published in industry "blue books," available at
car dealerships. Industry analysts or associations can often estimate the value of business or
industrial equipment. County or local property assessors should be able to verify the value of land
and/or buildings in their jurisdiction. It will be particularly important to seek out this information
if you are analyzing a real estate or land development partnership.

Once you have reviewed this information, you can complete the Luxury Assets and
Undervalued Assets portions of this worksheet section.

Part A - Luxury Assets

Provide the following information for each of the partnership's luxury assets.

•	Asset and use. Describe the asset (for example, note make and year of
luxury vehicles, location of rental property or buildings) and its use. In this
section you may also want to explain why you consider this asset to be a
"luxury" for the partnership.

•	Estimated market value. Note the market value of the asset and the source
for this information.

•	Balance due on loan. Note here any remaining loans outstanding on this
asset.

•	Replacement cost Estimate the cost of substituting luxury assets that are
being used by the company with less expensive replacements. For example,
company officers may need vehicles to conduct business, but they don't
necessarily need luxury vehicles.

•	Potentially available. To estimate funds potentially available for this asset,
subtract the outstanding loan amount from it's market value.

•	Total potentially available net of replacement Add the potentially available
value of all the luxury assets you've investigated and note on Line 10.

5-5

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Part B - Undervalued Assets

his section, note on the worksheet any discrepancies between the book value of an asset
and ib . .irket value.

•	Asset and use. Describe the asset and its use in the business.

•	Book value. Note the value as stated on the company's financial statements
or tax return (Schedule L "Balance Sheet" on Form 1065).

•	Estimated market value. Note the market value of the asset and the source
for this information.

•	Total estimated excess value of assets. Sum the difference between estimated
market value and book value of all undervalued assets and enter the amount
on Line 11.

Section V - Business Expenses

In this section of the worksheet we review the partnership's expenses, evaluating their level
and necessity. Partnership expenses are listed as deductions on Form 1065, Items 9a through 20.
Be certain to examine any attached statements that detail expenses under Item 20 "Other
deductions."

In your review of partnership expenses, pay particular attention to travel and entertainment
or subsistence expenses, vehicle expenses, and office expenses and supplies. Such expenses may
mask funds going to partners or employees (for example, vehicle expenses might also include
personal use of vehicles). Also examine closely any expenses paid to related parties (e.g., partners),
such as expenses for professional services or subcontractors.

•	Expense category. Review the partnership's expenses and list those that you
believe can be reduced without materially affecting the operations of the
company.

•	Amount expended. Note the annual amount for each expense that you
believe can be reduced.

•	Possible reduction. Enter the reduction that you think is reasonable.

•	Total possible reduction in expenses. On Line 12, sum all possible reductions
in expenses.

•	Justification for reduction. Describe here your reasons for any possible
reductions.

5-6

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Section VI - Case Disposition

In this section of the worksheet we summarize our findings and reassess the violator's ability
to pay. This analysis has two steps: (1) a cash flow calculation, and (2) an equity assessment. For
a partnership, equity in the company will be reflected in the partners' capital accounts (Form 1065,
Schedule M-2, Line 9). These accounts measure the net worth of the partnership (assets less
liabilities).

Part A - Cash Flow

As explained in Chapter 2, our manual cash flow calculation is simply adjusted net income
less adjusted expenses. This figure is computed as follows:

•	Total partnership income. On Line 13, enter pre-tax income to the
partnership as reported on Form 1065, Item 8.

•	Depreciation, depletion and amortization expenses. In Chapter 2 we explain
that these are non-cash expenses that do not affect a company's cash flow.
We therefore add these expenses back into the partnership's income. Sum
the amounts claimed on Form 1065, Lines 16a and 17 and enter the sum on
Line 14.

•	Total pre-tax cash flow. On Line 15, sum the amounts on Lines 13 and 14.

This amount represents the partnership's pre-tax cash flow.

•	Reductions in expenses. On Line 16, enter the total from Line 12 in Section
VI, Part B of this worksheet.

•	Estimated pre-tax cash flow. Add the amounts on Lines 15 through 16 to
estimate potential partnership pre-tax income on Line 17.

•	Tax adjustment Multiply this amount by one minus the highest income tax
rate for individuals (1 - 0.33 = 0.67) and enter the result on Line 18.6

•	Non-cash deduction tax benefits. Multiply the amount in Line 14 by the tax
rate (0.67), and enter the result on Line 19.

•	Estimated after-tax cash flow. Add together Lines 18 and 19. This amount
represents an estimate of what the partnership might be able to produce in
after-tax cash flow in the coming year, if income remains steady and expenses
are reduced.

0 We use the individual income tax rate because partnership income is passed on to the partners.

5-7

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As an example, let's assume that Partners in Land Development (PLD -- a fictitious
partnership) declared a net loss of $465,392 in the year you are analyzing.7 We add back to this
figure depreciation, amortization and depletion expenses, as they are not cash expenses for the
partnership and do not increase the company's annual cash outflows. PLD claimed $17,685 in
depreciation for the year. Adding back this amount gives us a net loss of $446,506.

Suppose your investigation has shown that the partners in the firm are not receiving any
income from PLD's activities; in fact, they are claiming a loss on their individual Schedules K-l.
You believe, however, that the partnership can feasibly reduce other expenses by about $2,000 per
year. This amount decreases PLD's net loss to -$464,192. Adjusting this figure for taxes yields a
loss of -$311,009 (-$464,192 x 0.67).,

Next, add back the tax benefit of PLD's non-cash deductions. Multiply PLD's depreciation
expense by the tax rate ($17,685 x 0.33) and reduce the loss by the result ($5,836). PLD's estimated
after-tax cash flow is thus -$305,173 (-$311,009 - $5,836). In other words, on an after-tax basis, PLD
has negative cash flow. We cannot look to cash flow as a source of penalty funds.

Part B • Equity Assessment (Partners' Capital Accounts)

In assessing PLD's equity we want to determine: (1) the value of assets that could be
liquidated to provide penalty funds, and (2) the true equity of the partnership, based on the value
of its remaining assets.

To begin, enter the amount from Line 10 in Section IV, Part B on Line 21 of this worksheet.
This amount summarizes your earlier review of all assets, and lists the net value of those that can
be liquidated, net of replacement costs for less expensive, substitute assets. Next, we summarize
equity information gathered on the partnership's remaining assets and liabilities. To calculate the
value of these assets, follow the steps below:

•	Adjusted partnership assets. On Line 22, enter the adjusted value of
partnership assets. To calculated this figure, subtract liquidated assets from
assets as they appear on Form 1065, Schedule L, Item 14(d).

•	Estimated excess value of undervalued assets. On Line 23, enter the total on
Line 11 of Section IV, Part B of this worksheet.

•	Adjusted value of assets. Sum Lines 22 and 23 and enter the total on Line
24. This figure represents the adjusted value of the partnership's equity.

•	Estimated adjusted equity. Subtract partnership liabilities from Line 22
above. This result is an estimate of partnership equity.

7 Recall that it is common for real estate concerns to have negative income (i.e., a loss).

5-8

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Assume that during your investigation you discovered that PLD owns only one significant
asset -- a piece of land with a stated value of approximately $9 million. Your investigation into the
property's market value indicates that this figure does not need adjusting. The partnership's
remaining mortgage on this land equals about $2.5 million. Therefore, the net value of this land
to the partners is approximately $6.5 million before taxes.

Suppose that you leam that, the partnership plans to develop this land for both commercial
and residential use; and, further, that similar projects have earned their owners very large returns.
Using this information, you could argue that the PLD Partnership could produce penalty funds by
selling its land. In this case, enforcement staff would have to consider the penalty and circumstances
carefully, since selling the land would certainly affect the partnership's material position.
Alternatively, the partners could borrow approximately $3.8 to $4.7 million (with the real estate as
collateral and using conservative financing assumptions) to produce funds for the penalty.8

Part C - Case Disposition

In the example above we determined that, although the violator had negative cash flow,
equity in the partnership was such that the violator had the potential to generate penalty funds
through loan financing. This information allows you to complete summary Lines 24 through 26.
Under Part E - Final Status, you can also check that your analysis is complete. In other ability to
pay cases, your review of the ,violator's cash flow and eqbity position might demonstrate that the
partnership does not have funds available for the penalty. These cases will require an in-depth
investigation of each partner. Determining each partner's individual ability to pay will give you an
assessment of the funds that each can contribute towards a penalty. Follow the worksheets and
instructions in this document for assistance in analyzing each partner. For general partners that are
Subchapter C corporations, consult Chapter 3. For partners that are Subchapter S corporations,
consult Chapter 4. For partners who are individuals, consult Chapter 7. For partners that are
themselves partnerships, use the worksheets in this chapter. Keep in mind that limited partners are
only liable to the extent of their investment.

Gearly the number and variety of the partners in a partnership will add to the complexity
of your analysis. For help on those cases that involve many partners and/or complicated
relationships, consult a financial analyst.

8 PLD's land is worth an estimated $9.0 million. Assuming partnership debt capacity of 70 to
80 percent (all dollars are in millions):

a)	$9.0 x 0.80 = $7.2 - $2.5 (current mortgage) = $4.7

b)	$9.0 x 0.70 = $6.3 - $2.5 = $3.8

-------
PARTNERSHIP

EXTENDED ABEL ANALYSIS

Section I. General Information

1.	Violator's name:

2.	Address:

3.	Type of partnership (check one): 	Limited 	General

4.	Principal business activity and product or service (1065, items A and B):

5. Original penalty amount



6. As a percent of income (penalty + Line 8 on
Form 1065)



Section II. Financial Information

7. Tax returns and schedules available

Year
Prepared





























8. Financial Statements provided

Audited? Y or N

Period(s) covered

































L

-------
PARTNERSHIP
EXTENDED ABEL ANALYSIS

	

Section 0. Financial Information (continued)

9. Other violator or genera] industry information collected and date of docuraent(s):

-------
PARTNERSHIP
EXTENDED ABEL ANALYSIS

Section III. Ownership and Operating Affiliations (from tax form, Financial Statements and
D&B report)

Part A. Partner Information

General Partner:



Type of entity:



Percent ownership:



Guaranteed payments to partner:



General Partner:



Type of entity:



Percent ownership:



Guaranteed payments to partner:



General Partner:



Type of entity:



Percent ownership:



Guaranteed payments to partner:



Part B. Other Partnerships

Is the violator a partner in any other partnerships?

Yes

No





Name of partnership:



Principle business activity:



Information required for further analysis:



-------
PARTNERSHIP

EXTENDED ABEL ANALYSIS

Section IV. B ashless Assets (Use data from 1065 Schedule L, compare with Financial Statements)
Part A. Luxury Assets

Asset and use

Estimated market
value and source

Balance due
on loan

Replacement
cost

Potentially
available



















































10. Total potentially available net of replacement





Part B. Undervalued Assets

Asset and Use

Book
value

Estimated
market value

Value
difference









































11. Total estimated excess value of assets



-------
PARTNERSHIP

EXTENDED ABEL ANALYSIS

Section V. Business Expenses

Expenses

Expenses category

Amount
expended

Possible reduction

























12. Total possible reduction in expenses



Provide justification for reductions specified above:



-------
PARTNERSHIP
EXTENDED ABEL ANALYSIS

Section VL Case Disposition

Part A. Cash Flow

13.

Total Partnership Income



14.

Depreciation/Depletion/Amortization



15.

Total pre-tax cash flow



16.

Total estimated reduction in expenses

+

18. Tax adjustment [0.67 x Line 17)

20. Estimated after-tax cash flow (Line 18 + Line 19)

Part B. Equity Assessment (Partners' Capital Accounts)

Asset Liquidation

21. Estimated excess value of luxury or unnecessary assets





Equity Valuation



22. Adjusted partnership assets (subtract liquidated assets)







+

23. Estimated excess value of undervalued assets

24. Adjusted value of assets

25. Estimated adjusted equity (adjusted assets minus liabilities)

17. Estimated pre-tax cash flow

19. Non-cash deduction tax benefit (Line 14 x 0.33)

-------
PARTNERSHIP
EXTENDED ABEL ANALYSIS

Section VL Case Disposition (continued)

Part C Case Disposition

26.

Violator's estimated after-tax cash flow for 19

•

27.

Estimated assets potentially available for liquidation



28.

Violator's estimated adjusted equity

Part D. Final Status

Analysis completed

Pursuing further analysis

Analyst's Name

Date

-------
1065

U.S. Partnership Return of Income

'3 >jc :-i-:C99

¦ ^ w w

Ieoanrre'*! c' '~e 'r-?asurv
-lemai Sendee

For caienaar year 1991. or tax year Beginning . 1991. ana ending	'9

~ See seoarate instructions.

491

Pnncioai sus.ness act.vitv

Us« ihe 1 ",ame 01 oannersnio
IRS

~ EmgiBYtr id«milicilmn numotr

PnnciGai orcauc; or service

- , Jumoer street ana room or suite no ut a P O oo*. see oage 9 ot tne instructions 1

wis#,

E Gate ousiness siarieo

C Susmess coce numoer

pJJ'jU™" c.ty or town, state, ana ZIP coae
or type. 1

F Toai uuts i»t iotcnic insiruoonu

S

G Cr.ecK aDDiicaDie oones: (1) LJ 'mtial return
H Cr.ecK accounting metnoa: (1) Lj Casn
I 'Jumoer or manners m this oannersnio.

(2) I	 Final return

(2) L Accrual

(3) U Change in aadress
(3) G Other (specify)

(4)

Amenaea return

Caution: irciuCe only trade or business income ana excenses on lines la through 22 below See the instructions for more information.

I

1	a Gross receipts or sales

b Less returns ana allowances.

2	Cost at gooas sold (Schedule A. line S)

1a

1b i

1c !

2 !

£ | 3 Gross orofit Subtract line 2 from line 1c

o I

4 Qramarv income uossi from other oartnersnios and fiduciaries lattach schedule)

— • 5 Net,farm orotit ilossi lattacn Scheauie F tForm 1040))
6 ^let gam iloss) from Form 4797. Part II ime 18

5 i

7 Other income dossi (see instructions) lattacn schedule)

7 '







HIP







9a Salar es and wages lother tnan to oartnersi
b Less loos credit

9a







0

9b

! 9c I



10	Guaranteed oayments to oanners

11	Rent ,

12	interest
a ! 13	Taxes

2 I

16a i

10 I

11 I

12

13

i 14 Sad debts
; ,15 neoairs
16a Deoreciation isee instructions!

: b Less deoreciation reDorted on Schedule A and eisewnere on return 16b I	

' 17 ^eoietion (Do not deduct oil and gas depletion.)

: 18 Retirement olans. etc.

; 19 Emooyee oenefit programs

i

i

¦ 20 C;her aeauctions lattacn schedule)

21 Total deductions. Add the amounts snown in ;ne far nqnt column for lines 9c through 20

14

15

16c

17

18

19

20

i '
21 1

22 Ordinary income (loss) from trade or Dusiness activities. Subtract line 21 from line 8

22

unaer oena»nes or oenury t ceciare mat» rave e*arnireo trij return ir,c:uo>ng accorrioanying screouies ana statements, ana to tne oest of tv -.no^ieoge
ana oe'iet it is true, correct ana comoiete Declaration 01 oreoaref iotner man general Gartner) 13 oasea on an information o* wnicn oreoarer nas any
-^owieage

Please

Sign

Here

S ^nature 01 general oanrer

Oate

Paid

Preparer $
Use Only

P'eoarer s

signature

~

1 Date

j ChecK if
seit-emoiovea ~

Preoarer s social security

" "Ti's name ior
.ours if seif-emoioveai
jna aaaress

E.I. No ~

ZIP coae »

For PaoerworK Reduction Act Notice, see cage 1 of separate instructions.

Cat. no 1 I390Z

-orm 1065 i ;3911

-------
¦ 5 m99*

Cost of Goods Sold

Schedule A

1	'	inventory at oegmnihg of vear	1

2	Purcnases ess cost of items witnarawn tor personal use	2

3	Cost of laDor	i	3 I

i

4	Aaamonai section 263A costs isee instructions! lattacn scnedulei	'	4 ;

5	Other costs lattacn scnedule)	•	5 1

6	Total. Aaa unes i tnrough 5	. '	6 ¦

7	inventory at end of year '	I	7 '

S Cost of goods sold. Suntract line 7 from une 6 Enter nere ana on page 1. line 2	8	

9a CnecK an metnoos used for valuing ciosing inventory

(i)	Z Cost

(ii)	_ Lower or cost or market as oescnoeo in Regulations section 1 471-a

(ni) 	 Writeaown c' suonormai' aooos as oescrioea m Regulations section 1 J71-2ici

(iv) _ Otner isDecirv metnoa usea ano anacn exoianationi ~	

b Check tnis oox if tne UFO inventory metnoa was aaoDted tnis tax year tor any goods hr cnecxea. anacn Form 97C " ~ Z
c Do tne ruies cf section 263A (for prooerty Droaucea or acauired for resaiei apply to the oartnership'' _ Yes Z No
d Was tnere anv cnange in aeterminmg quantities, cost, or valuations between opening arid closing inventory' Z Yes Z No

if "Yes.1 attach explanation		

F^fl!TF!ri;l otner Information

1	Is this partnersmp a limited partnership"7

2	Are any partners in tnis oartnersnip also oartnersnips''

3	Is tnis partnersniD a oartner m anotner oartnersnip''

4	is this oannersnio suDiect to the consohoateo audit procedures of sections 6221 through 6233'' If "Yes ' see
Designation of Tax Matters Partner oeiow

I Yea,
I '

5	Does tnis oartnersnip meet all the requirements snown in tne instructions for Question 5?

6	Does tnis partnership nave any foreign partners7

7	is tms partnership a ouDhciy traded partnership as defined m section 469(k)(2)9

8	Has tnis partnership fneo. or is it reauired to file Form 8264, Application for Registration of a Tax Shelter?

9	At any time ounng tne tax year, did tne oartnersnip nave an interest in or a signature or other authority over a
Tinanoai account m a foreign country isucn as a oank account, securities account, or otner financial accounts
(See tne instructions for exceotions and filing requirements for form TD F 90-22.1 ) If "Yes." enter the name of
tne foreign country ~ 	

10 Was tne Dartnersmo tne grantor of. or transferor to a foreign trust which existed ounng the current tax vea'
wnetner or not the partnership or any partner nas any oenefioai interest m it9 If "Yes." you may nave to fne
Forms 352C. 3520-A. or 926

11. Was tnere a oistriDution of property or a transfer (for example, ov saie or death) ot a oartnership interest ounng
tne tax year7 if "Yes. you may eiect to aaiust the oasis of the Dannersnip s assets unoer section 754 by attacn,ng
tne statement aescrioea unqer Elections on oaae 5 of tne instructions	

Designation of Tax Matters Partner (See instructions.)

Enter oeiow tne general oartner aesignatea as tne tax matters partner ITMP) for the tax year of this return

Name of	w	Identifying k

aesignatea TMP Y	numDer of TMP W

Aaaress of
aesianaied TMP

-------
33q« <

Schedule K

Partners' Shares of Income. Credits. Deductions. Etc.

(a) Distributive snare items

:b) Total amount

s>
o

0
o
s

u

3

^ c
o
2 —

1	Ordinary income uossi trom traae or business activities ipage i ;ne 22)

2	Net income doss) from rental real estate activities lanacn Form 3325)

3a Gross income from otner rental activities	3a	

b Less expenses (attacn scneauiei		

c Net income (loss) from other rental activities

4	=ortfono income Oossi (see mstructionsi.
a Irterest income

b Diviaena income
c Royalty income

d Net snort-term capital gain Uossi (attacn Schedule 0 tForm i065i)
e Net-long-term caoital gam (loss) tattacn Scheauie 6 (Farm '055)1
1 Other oorrfolio income iiossi (attacn scneauiei

5	Guaranteed payments to partners

6	Net gain (loss) unaer section ,1231 (otner ,tnan aue to casualty or tneftl /attacn Form 4 797)

7	Other income doss) (attacn schedule)			

8	Charitaole contnOutions (see mstructionsi (attacn tisti

9	Section 179 exoense deduction tattacn Form 45621

10	Deductions related to oorttolio income isee mstructionsi utemizei

11	Other deductions tatracn scneauiei			

4b

4c

4d

4«

4f

10

11

i/>

qj C 4)

> 
5

k.

o

17a ".ie ci mcome ~ 	 b Foreign ccuniry or U S possession*

c Total gross income trom sources outside the U S. (attacn scneauiei
d Total aoDiicaOle deductions and losses tattacn scneauiei
e Total foreign taxes (check one). ~ d Paid C] Accrued
f Reduction m taxes available for credit tattacn scneauiei
g Other 'oreign tax information (attach scneauiei		

17d

17a

17f

17g_

r

18a Total exoenditures to which a section 59(e) election may appiy

b Type ot exoenaitures *• ' 	

19 Z:~er 'tens ana amounts reauirea to oe reoonea seoarateiv to oartners isee instructions) ismcft scneauiei

18a

1/1
f3
<

20a income iloss) Comoine lines 1 througn 7 m column id) From tne result. suOtract ihe

sum.of !mes 8 througn 12a. I7e. and 18a	

b Analysis oy type — 		 1	(b» ina.v.auai

of Dartner:

20a

(a) Corporate r

Active

Passive

(c) Partnersnio i

(d) Exemot
organization

(e) Nominee/Other 1

(1) Ge^e'ai oartners i_
12) l ~ -m oartners ¦

-------
schedule k-i Partner's Share of Income. Credits. Deductions. Etc.	; :'/B No

(Form 1065) j	^ See separate instructions.

.¦ia«nm»nt ot -re •i-easurv | -	Vr ¦

'¦-a -f-vc? ' Por calendar year 1991 or tai /ear oeginning	 , '991 and enomq	' 9	J 
-------
2





(a) Distributive snare item



|0) Amount

icl 1040 filers enter tne
amount in column i0| on-

5

u

15a

"•jet earnings nossi 'rom seif-emoiovment

15a i



Sen. SE. Section A or 3



b

Gross rarmmg or risnmg income

15b i



• I / Se« Partner 5 'fstrjc: ens 'zr \

a.

c

Gross nor.tarm income

15c i



j \ ^c-eou>8 * ' Cc"" /

X

£ 2

IS

¦5 —1

¦fi 0) i

c c:

S i" ¦

5 ®

3 £¦

f1'

16a
b

c
d
e

1

-cceieratea aeoreciation ot reai Drocertv oiacea m service oefore
•987

Acceieratea aeoreciation of ieasea oersonai orooeny oiacea m
service cetore 1987.

Ceoreoanon aaiustment on orcoerrv oiacea in service after 1986
Oeoietion lother man on ana gasj

(1)	Gross mcome from oil. gas. ana geotnermai orooerties

(2)	Deauctions ailocaDie to oil gas. ana geotnermai Drooerties
Other aoiustments ana tax orererence items lattacn scnedule)

16a i

16b I

16c i

I6d l

e(1) I

e(2)l

16f

(See Partners
Instructions ror
v Schedule K-1
/ (Form 10651 ana
Instructions for
Form 6251.)

i/i

aj

£

c
01

o
u.

17a	fvoe ot income ~ 	

b	Name of foreign country or u S oossession ~	...

c	Total gross income from sources outside the u S lattacn
zcneauiei

d	Tctai aopiicatjie aeauctions ana losses lattacn scneauiei.

e	Total foreign taxes icnecK onei ~ 1	3aid —Accrued .

f'	Peduction >n taxes avanaoie tor creait lattacn scneauiei

g	Other 'oreion tax mtormation iatracn sc'eomei	

17d i

17a l

17f

17g i

Form 1116. ChecK ooxes
Form 1116. Part I

Form 11*6 ?3rt II
Form 1115 Parr ill

ye I^cin C	- —

5

18a
b

19

a
b

Total exoenaitures to wmcn a section 59(el election mav apply
Tvce of exoenaitures ~	....	....

Recapture of low-income nousmg creait
From section 4-2(0(5) pannersmos
Other tnan on line 19a

19b I

See Partner s
Instructions tor
Scheauie K-1
(Form 1065)

Form 8611. line 8

20 Supplemental information recuireo to ce reported separately to each partner
neecea):

lattacn aaoitionai scneaules if more scace is

V)

-------
Caution: Reaa tne instructions tor Question 5 of Screauie 3 or, cage '4 of tne instructions oerore completing Scneauies u
M-1 and M-2

Schedule L

Balance Sheets

Assets

1 Casn

2a Traae notes and accounts receivable
b Less allowance tor oaa aeots

3	Inventories

4	US government obligations

5	Tax-exempt securities

6	Otner current assets rarracn scneduiei

7	Mortgage ana real estate loans

8	Otner investments (atracn scneauie)
9a Buildings ana otner depreciable assets

b Less accumulated aeDreciation
10a DeoietaDie assets

b Less accumulated depletion
11 Lana met of any amortization)

12a intangioie assets (amortizaoie oniyi
• b Less accumulated amortization

13	Otner assets lanacn scneauiei

14	Total assets

Liabilities and Capital

15	Accounts payable

16	Mortgages notes, oonas DavaDie in less tnan i year

17	Otner current liabilities tattacn schedule)

18	All nonrecourse loans

19	Mortgages notes. Donas oayable m 1 year or more

20	Otner liabilities (attacn scneauie)

21	Partners' capital accounts

22	Tot^l liabilities ana capital

Beginning of tax year

End of tax year

Schedule M-1

Reconciliation of Income per Books With Income per Return

Net income oer Dooks
income inciudea on Schedule K lines 1
tnrougn 7 not recoraea on oooks tms year
ntemize) 	

Exoenses recorded on books this year not
mciucea on Schedule K. lines i tnrougn
12a. 17e. and 18a |itemi2e):

Oeoreciation S 	

Travel ana entertainment S	

4 Total of unes i tnrouan 3

5 income recorded on dooks tms year not inciuaea

on Scneouie K lines 1 tnrough 7 |itemize)
a Tax-exempt interest S ...:	

; Deductions included on Schedule K. lines i
tnrougn 12a. I7e. and 18a. not cnarged
against oook income tnis year (itemize),
a Depreciation $ 	

7	Total of lines 5 and 6	. .

8	Income (loss) (Schedule K. line 20a). Line 4
less nne 7		

Schedule M-2

Analysis of Partners' Capital Accounts

1	Balance at Beginning of year

2	Caoitai contnouted aunng year

3	Net income Der books

4	Otner increases ntemizei . .

Distributions: a Cash .

b Property
Other decreases (itemize):

5 Totai of nnes 1 tnrouan -

8	Total of lines 6 and 7

9	Baiance at end of vear. Une 5 less ime 8

'U.S.Gownmtm Porting 0"'C#

- 235-2^9

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SOLE PROPRIETORSHIPS

CHAPTER 6

A sole proprietorship is a business entity owned and operated by an individual. As with
partnerships, sole proprietorships are not subject to federal income tax; rather, the income from the
business is passed on to the owner. Income from the business is reported on the Individual Federal
Income Tax return Form 1040, Schedule C, and is taxed along with other income the individual
might receive.

A sole proprietor is responsible in full for the liabilities of his or her company. Often, the
income, assets, and liabilities of a sole proprietorship are indistinguishable from those of the owner.
For this reason, an ability to pay analysis of a sole proprietorship should also include an analysis of
the owner's assets, liabilities and expenses. This chapter presents a method for conducting such a
combined analysis.1

To analyze a sole proprietorship, enforcement staff will have to collect information on both
the business and the individual. As with the other business entities discussed in this manual, you
will need to obtain complete tax returns for the past three years (Form 1040, plus Schedule C and
any .other relevant schedules) and any available financial statements for the business.2 Individuals
should also complete and return to the EPA an Individual Financial Data Request Form (IFDRF),
a blank copy of which can be found at the end of this chapter. On this form, individuals provide
detailed information about their personal assets, liabilities, and expenses.

The ability to pay process for sole proprietors is a slightly different approach than that for
a corporation or business. The sole proprietor worksheets begin with some basic information about
the company, followed by an analysis of the proprietor's combined personal and business income.
Next we assess the violators's equity by evaluating his or her assets and liabilities. In the final
worksheet section, we calculate the violator's cash flow and equity.

1	Chapter 7 presents a method for analyzing individuals only. The worksheets in the Chapter
7 should be used when analyzing an individual without an operating business, or those individuals
involved in partnerships or corporations that have personal responsibility for their company's
liabilities.

2	If the sole proprietor has not prepared nnanciai statements, they can complete a copy of the Sole
Proprietorship Balance Sheet attached to the Individual Financial Data Request Form.

6-1

-------
Because of the depth and detail required in these cases, we will work with a sample case
through this chapter. Before completing the sole proprietorship worksheet, be certain that you have
read Chapter 2, as it contains important information on the questions in this worksheet.

Section I - General Information

The first section of the worksheet summarizes basic information about the violator, and
information that has been collected thus far. Throughout this case we will use the example of Russ
T. Tank, the sole proprietor of a gasoline service station.

- • Violator (Business): On Line 1, enter the name of the business, noted in
Item C on Schedule C of the Form 1040.3 In our example, the business
name is Tank's Full of Gasoline.

•	Address: On Line 2, enter the violator's business address, which is Item E
on Schedule C of the Form 1040. Tank's business address is 60 Madison
Road, Alvord, Iowa.

•	Proprietor On Line 3, enter the name of the business proprietor, reported
on the top line of Schedule C.

•	Principal business activity and product or service: On Line 4, enter the
violator's principal business activity, along with its product or service. This
information can be found on Form 1040, Schedule C, Item A.

•	Original Penalty Amount: Note on Line 5 the proposed penalty amount.

Section H - Financial Information

In this section of the worksheet we summarize the financial available information.

•	Tax returns and schedules. On Line 6, enter the' forms and schedules
supplied, along with the year of the return. Note also whether any tax
information is missing. For Tank and his service station we have Form 1040
and Schedule C for 1989,1990, and 1991. Tank has also attached Schedules
A, B, SE and E to his personal return.

•	Financial Statements. On Line 7, list all available financial information. This
should include the IFDRF that the violator completed. The violator should
also provide Balance Sheets and Income Statements for the business. Note
the period covered by each statement, particularly if the statement covers
only a portion of a fiscal year. Also note whether any necessary or useful

3 Throughout this chapter we reference the 1991 version of the Form 1040. Specific item locations
may differ for previous years' forms.

6-2

-------
information is missing. Tank has sent Income Statements and Balance
Sheets for his business covering fiscal years 1989, 1990 and 1991.

•	Other information on violator or industry. On Line 8, list any other material
you have obtained. Examples of such information include Dun & Bradstreet
reports, a company prospectus, loan applications, and so forth. Note as well
the period covered by the document. For our example, we were able to
obtain a common-size statement for service stations with total assets below
$50 million to use in our asset and liability analysis.4

Section III - Ownership and Operating Affiliation^

This worksheet section details relationships that the violator has with other businesses. This
information will indicate whether entities beyond the violator and his or her company should be
considered in the ability to pay analysis. For example, check to see if the sole proprietor is also an
officer or controlling shareholder in a closely held corporation, a partner in a partnership, or the
owner of another sole proprietorship. This information should have been provided in the violator's
Individual Financial Data Request Form.

•	Additional business concerns. Is the owner or is the business affiliated with
any other business concerns? Check yes or no. Tank is not affiliated with
any other business.

•	Name of Entity. Note the name of each related entity.

•	entity. Note whether the entity is a corporation, partnership, or sole
proprietorship.

•	Relationship and documents available. Describe here the relationship
between the two entities, and the percentage of the business owned by the
violator. Also note any documents on the related entity that are currently
available.

In the summary portion of this section of the worksheet, discuss whether other entities
should be included in the ability to pay assessment for this violator. In many instances this
determination will require advice from a financial expert. Continue to work on the violator's ability
to pay assessment while you pursue information about the proprietor's other business interests.

4 Common-size statements compare assets, liabilities, income and expenses across businesses
within an industry. These statements generally -how the average percentage of net sales or total
assets consumed by each category of expenses or liabilities. Consult Chapter 2 and Appendix A for
ideas on additional sources of industry information.

6-3

-------
Section IV - Income

In this section of the worksheet, we evaluate the violator's income as reported on its most
recent Form 1040 tax return. Income for the violator will consist of the income produced by the
sole proprietorship, and any other income claimed on the violator's Form 1040.

Part A - Business Income

In Part A we compute business income by adding back paper write-offs and (if necessary)
adjusting expenses.

•	Business income. Note the violator's business income as reported on Line
12 of the .1040 form. From Tank's return we see that he has claimed $38,208
in business income. To obtain more information about the business, refer to
Schedule C - Profit or Loss for Business.

•	Depletion. On Line 13 of the worksheet, record any depletion that the
violator has claimed for his or her business (See Line 12 of Schedule C).

Tank did not claim any depletion for his station. Enter zero on Line 13.

•	Depreciation and/or Amortization. On Line 14 of the worksheet, record any
depreciation or amortization that the violator has claimed for his or her
business. Depreciation and amortization are real business costs; however,
they do not increase a company's annual cash outflows. For that reason,
depreciation and amortization expenses are, added back into a company's
income when computing cash flow. On Line 13 of Tank's Schedule C, he
claimed $4,115 in depreciation for the year. Enter this figure on Line 14 of
the worksheet.

•	Total business income. Enter the total of the values on Lines 12 through 14
on Line IS. Tank's total business income equals $42,323.

Part B - Personal Income

In this section, we sum other sources of income as reported on the individual's Form 1040.
In some cases, the violator may have sources of income that are not taxable, but that should be
included in his or her total income for purposes of this analysis.

•	Wage income. On Line 16 of the worksheet, enter the violator's wage
income as reported on Line 7 of the Form 1040. Tank's wage income in
1991 was $11,401.

•	Taxable interest income. From Line 8a on Form 1040, note if the violator
has claimed taxable interest income. Examples of taxable interest income
include interest from checking and savings accounts, and interest from bonds
and treasury bills. (See the 1040 Instruction Booklet for a full explanation

6-4

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of each line entry.) In our example, Tank has claimed $2,265 in taxable
interest for the year. Enter this on Line 17 of the Worksheet.

•	Tax-exempt interest income. From Line 8b on Form 1040, note if the
violator has claimed tax-exempt interest income. An example of tax-exempt
interest is the interest earned on a municipal bond. Tank has not made an
entry in this line. Enter zero on Line 18.

•	Dividend income. On Line 19 of the worksheet, enter any dividend income
reported in Line 9 of the tax return. Enter zero for Tank since he did not
report dividend income.

•	Alimony received. On Line 20 of the worksheet, enter alimony reported in
Line 11 of the tax return. Enter zero for Tank since he did not report any
alimony.

•	Total IRA distributions. On Line 21 of the worksheet, enter any
distributions from IRA funds reported in Line 16 of the tax return. If an
entry is made in both Line 16a (total value) and Line 16b (taxable portion),
enter the amount from Line 16a. However, if the IRA distribution is fully
taxable, an entry will be made in Line 16b only. If this is the case, enter the
amount from Line 16b. Enter zero for Tank since he did not report any IRA
distributions.

•	Total pensions'and annuities. On Line 22 of the worksheet, enter any
pension and annuity income reported in Line 17 of the tax return. If an
entry is made in both Line 17a (total value) and Line 17b (taxable portion),
enter the amount from Line 17a. However, if the pension is fully taxable, an
entry will be made in Line 17b only. If this is the case, enter the amount
from Line 17b. Enter zero for Tank since he did not report any pension or
annuity income.

•	Total social security. On Line 23 of the worksheet, enter any Social Security
income reported in Line 21a of the tax return. Be careful to enter the value
on 21a (the total) and not the value in the rightmost Line 21b. (The value
in Line 21b represents only the taxable social security, here we want to
account for all income.) Enter zero for Tank since he did not report any
Social Security income.

•	Total income (or loss) from rental or royalty properties. On Line 18 of Form
1040, the filer is asked to record income from rents, royalties, partnerships,
estates and trusts. To get a breakdown of each of these income sources, we
need to consult Schedule E, which details each of these income sources. If
an entry is made in Line 18, a Schedule E must accompany the 1040 tax
return. Tank has claimed $2,340 in rental income on his Schedule E. Enter
this figure on Line 24 of the worksheet.

6-5

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•	Depreciation or depletion on rental property. Recall that to calculate an
violator's net business cash flow, we must add back the depletion and
depreciation expenses claimed on the tax form. Therefore, we add back
depreciation on rental property to calculate cash flow from this asset. Note
that on Line 20 of Schedule E, Tank has claimed a depreciation expense of
$680. Enter this amount on Line 25.

•	Partnership/Subchapter S corporation income. Also on Schedule E, violators
must detail income or loss from Partnerships and Subchapter S Corporations.
The total income from these sources is recorded on Line 31 of Schedule E.
Enter this amount on Line 26 of the worksheet. Enter zero for Tank since
he did not report this type of income.

•	Estate and trust income. Also on Schedule E, violators must detail income
or loss from Estates or Trusts. The total income from these sources is
recorded on Line 36 of Schedule E. Enter this amount on Line 27 of the
worksheet. Enter zero for Tank since he did not report any estate or trust
income.

•	REMIC income. Also on Schedule E, violators must detail income (or loss)
they receive as a holder of a residual interest in a Real Estate Mortgage
Investment Conduit (REMIC). The total income from these sources is
recorded on Line 38 of Schedule E. Enter this amount on Line 28 of the
worksheet. Enter zero for Tank since he did not report any REMIC income.

•	Farm rental income. If a violator has received income from farm property
that he or she is renting to someone else, he or she must declare this income
on a Schedule E. Note if income has been recorded on Line 39 of the
Schedule E. If so, enter this amount on Line 29 of the worksheet. Enter
zero for Tank since he did not report any farm rental income.

•	Depreciation on farm rental income. Individuals can claim depreciation
expenses on the farm property they rent to others, just as they do on other
rental properties. We add this expense back when calculating cash flow.
Tank does not rent any farm property or claim depreciation, so enter zero
on Line 30 of the worksheet.

•	Farm income. A violator must submit a Schedule F to report income and
expenses from a farm that he or she operates, or owns and operates.5 If an
entry was made in Line 19 of the 1040 return, a Schedule F must accompany
the 1040 return. If income is declared on Line 19 of the 1040 form, enter
this figure on Line 31 of the worksheet. Enter zero for Tank.

5 Normally, fanners report income from a crop in the year it is sold. However, because farmers can
pledge part or all of their production to secure government payments (e.g., CCC loans, PIK certificates),
they can elect to report a payment as income in the year it is received, rather than the year of crop sale.
If claimed as income these payments will be noted on Line 7 A of Schedule F. While these loans
represent income, we do not recommend that they be treated as cash.

6-6

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•	Depreciation on farm property. Depreciation on farm property and
-equipment is recorded on Line 17 of the Schedule F. As with depreciation
on other types of property, this expense is added back to calculate cash flow.
On Line 32 of the worksheet, enter the amount reported on Line 17 of the
Schedule F. Enter zero for Tank.

•	Capital gain (loss). From the 1040 tax form, add Lines 13 and 14 and enter
this total on Line 33 of the worksheet. Tank did not claim any capital gains
or losses for the year.

•	Other gains (losses). Enter the amount recorded on Line 15 of the 1040 tax
form on Line 34 of the worksheet. Tank did not claim any additional gains
or losses for the year.

•	Totai personal income. Add Lines 16 through 34 of the worksheet and enter
the proprietor's total personal income on Line 35. Tank's total personal
income (exclusive of that from his business) is $16,686.

•	Total income. Add personal income on Line 35 to business income on Line
15, and enter the total on Line 36. Tank's total income equals $59,009.

Section V - Net Cash Flow

The next step in this analysis involves determining the violator's cash flow. A simple way to
think of cash flow is the income left over after paying all cash expenses during a year. In calculating
expenses, we use data from the Current Living Expenses section of the Individual Financial Data
Request Form (Part II).

•	Total annual living expenses. Go to Part II of the violator's Financial Data
Form. Space for converting data to annual values is provided in the "For
Agency Use Only" column in the Current Living Expenses Section (Part II).
For weekly expenses, multiply by 52 and put the total in the "For Agency Use
Only" column. For monthly expenses, multiply by 12; and for quarterly
expenses multiply by 4. Sum this column of figures, ignoring Federal Income
Taxes (Line D.2 on the Financial Data Form), and enter the result on Line
37 of the worksheet.6 Russ T. Tank's total annual living expenses, before
Federal Income Taxes are $37,087.

•	Total annual debt payment Enter the violator's total annual personal debt
expenses. A violator's current debt expenses are important to determining
the violator's ability to acquire additional debt. Total lines B.l through B.4
on the Current Living Expenses Form. Enter this total on Line 38 of the
worksheet. Tank spends $9,769 on personal debt (his business debt equals
$71,341 as noted in Items 16a and 16b on Schedule C).

4 We ignore Federal Income Tax payments at this point because our cash-flow adjustments must be
done on a pre-tax basis; we will adjust for this later.

6-7

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•J Cash Flow. Once we have totalled income and expenses, we can calculate
the violator's cash flow for the year. Subtract Line 37 from Line 36. Tank's
pre-tax cash flow is $21,922. Enter this amount on Line 39.

Expense Evaluation

We now want to estimate whether the violator could improve cash flow by reducing business
or personal expenses. As noted in Chapter 2, business expenses might mask resources actually going
to the proprietor (e.g., high business travel expenses might actually include family vacation
expenses). Review these expenses (detailed in Form 1040, Part II of Schedule C) and, if possible,
compare them to industry averages. Do any expenses seem significantly above average values? Also
examine personal expenses (detailed in Part II "Current Living Expenses" of the IFDRF); do any
of them seem out of line?

It might help to compare the proprietor's expenses to those noted in the Consumer Price
Index measure of the relative importance of household expenditures included at the end of this
chapter. This index lists the percentage of income spent on certain goods and services for the
average U.S. urban household. Individual expenses clearly will vary from these measures, but the
index can be a, useful guide for determining the general range of household expenses. On the
worksheet, note the business and personal expenses that seem to be high, along with the reductions
you think might be possible.

•	Expense Category. List the expenses that you believe are inflated, or that
can be reduced without materially affecting the operations of the business or
the proprietor's standard of living.

•	Amount Note the annual amount for each expense that you believe can be
reduced.

•	Possible reduction. Enter the reduction that you find to be reasonable.

•	Justification for reduction. Describe here your reasons for any possible
reductions.

•	Total possible reduction in expenses. On Line 40, sum all possible reductions
in expenses.

•	Adjusted pre-tax cash flow. Add any possible reductions in expenses to pre-
tax cash flow and enter the total on Line 41. This total represents additional
cash flow that the violator may be able to generate if expenses can be
reduced. Our review of Tank's personal and business expenses indicates that
they are reasonable, and within the guidelines we consulted.

Section VI - ? Tet Worth

The next section of the analysis evaluates the violator's net worth. Net worth is measured
by subtracting liabilities from assets; it is similar to the notion of corporate equity, as it measures

6-8

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the material value of an entity or individual. To evaluate a sole proprietorship's net worth, we must
assess both personal and business assets and liabilities. The data for our analysis come from the Net
Worth Section (Part III) of the IFDRF, and the business Balance Sheet. We continue our example
with Russ T. Tank below.

Part A - Business and Personal Assets

Our review begins with the proprietor's personal assets. On Lines 42 through 49 of the 1040
worksheet, we enter subtotals for asset category specified on the Individual Financial Data Request
Form.

•	Bank accounts. Enter the subtotal from Question 1 on the Data Request
Form on Line 42 of the worksheet. Tank has a total of $19,301 in checking
and savings accounts.

•	Investments. On Line 43 of the worksheet, enter the subtotal for the
violator's investments. Tank has $20,000 in investments.

•	Retirement funds and accounts. Enter the subtotal from this question on
Line 44. Tank has zero in retirement funds.

•	Life insurance policies. Enter the subtotal from Question 4 on Line 45. The
value of Tank's life insurance policy equals $7,800.

•	Vehicles. On Line 46, enter the violator's estimate of the value of his
vehicles. Tank has entered $24,000 for this question.

•	Personal property. On Line 47 of the worksheet, enter the value of the
violator's personal property. For Tank this total is $17,000.

•	Real estate. On Line 48 of the worksheet, enter the subtotal for the value
of all real estate. Tank estimates this value to be $78,000.

•	Other assets. In Question 8, the violator totals the value of all other assets.

Tank has not listed any other assets. Therefore, enter zero on Line 49.

•	Total personal assets. Add Lines 42 through 49 on the worksheet and enter
this amount on Line 50. The total value of Tank's personal assets is
$166,101.

•	Business assets. Review the assets of the business as stated on the
proprietor's Balance Sheet, checking whether anv personal assets listed by the
proprietor are also claimed as business assets. On Line 51 note the total for
the business assets. .Tank's total business assets are valued at $471,419

•	Total assets. On Line 52, enter the sum of the values on Lines 50 and 51
above. This figure represents the proprietor's combined business and
personal assets. The value of Tank's business and personal assets equals
$637,520.

6-9

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Part B - Asset Evaluation

Our next step is to assess these assets to determine if any costly business or personal assets
are undervalued. Review the list of assets carefully. Do the given values seem reasonable? The
worth of assets valued at over $5,000 should be double-checked against outside sources. Vehicle
values are published in industry "blue books," available at car dealerships. Industry analysts or
associations can often estimate the value of business or industrial equipment. County or local
property assessors should be able to verify the value of land and/or buildings in their jurisdiction.
Provide information in this section on only those assets that are undervalued.

•	Asset and use. Describe the asset and its use.

•	Book value. Note the value as stated on the proprietor's Balance Sheet or
his or her Financial Data Request Form.

•	Estimated market value. Note the market value of the asset and the source
for this information.

•	Value difference. Subtract the book value from the market value and enter
this difference.

•	Estimated excess value of assets. Sum the difference between estimated
market value and book value of all undervalued assets and enter the amount
on Line 53.

•	Revised asset total. Sum the additional asset value as noted and enter the
adjusted asset value on Line 54. Our evaluation of Tank's assets indicate
that they are properly valued.

Part C - Business and Personal Liabilities

Next we review all personal and business liabilities. On Lines 55 through 59, enter
information about the proprietor's personal liabilities. Again, the data for our analysis comes from
the Net Worth Section (Part III) of the IFDRF, and the business Balance Sheet. We begin with
personal liabilities.

•	Credit cards and lines of credit On Line 55, enter credit debt for the
violator. Tank's total is $17,021.

•	Vehicle loans. Enter on Line 56 the subtotal for all car loans. Tank still
owes $12,560.

•	Furniture and household goods loans. On Line 57, enter any debt acquired
for household goods. Tank has entered $3,923.

•	Mortgages and real estate loans. Enter any outstanding real estate mortgage
balances on Line 58. Tank still owes $32,760 on his home.

6-10

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•	Other debt Note whether violator has listed any other debt. Here Tank
eaters a personal loan in the amount of $19,035. Enter this figure on Line
59.

•	Total personal liabilities. On Line 60, total all of the violator's liabilities.

Tank's total is $85,299.

•	Business liabilities. Review the liabilities of the business as stated on the
Balance Sheet, checking whether any personal liability listed by the
proprietor are also claimed as business liability. Subtract from the business
liability total liabilities claimed on both the Balance Sheet and the Individual
Financial Data Request Form. On Line 61, note the total for the business
liabilities. Tank's total business liabilities equal $274,662.

•	" Total liabilities. On Line 62, enter the sum of the values on Lines 60 and 61

above. This figure represents the proprietor's combined business and
personal liabilities. Tank's business and personal liabilities equal $359,961.

Part D - Net Worth Calculation

Once you have reviewed and totaled the value of all business and personal assets, you can
calculate the violator's net worth.

Net Worth. Subtract Line 62 from Line 54 to determine the violator's net
worth. (Keep in mind that this caji be a negative number. Negative net
worth simply means that an individual's debt is greater than his or her
assets.) Tank's net worth equals $277,559 and is entered on Line 63 of the
Worksheet.

Liability-to-asset ratio. Divide Line 62 by Line 54 to obtain the violator's
liability-to-asset ratio. This ratio simply shows the percentage by which the
violator's assets are offset by liabilities. Tank's liability-to-asset ratio is 0.56.

This means that his assets cover somewhat less than half his liabilities. Enter
this ratio on Line 64 of the worksheet.

Case Disposition

Determining ability to pay for a sole proprietor follows the same basic steps as the
determination for other entities. First we assess the violator's cash flow, that is, the amount of
income remaining after deducting all cash expenses. Recall that in our income assessment above,
we evaluate and combine business and personal income and expenses, as personal and business
funds overlap in many sole proprietorships. Next, we assess the individual's net worth, that is, the
value of all personal and business assets after deducting liabilities or debt.

Section VII -

6-11

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Part A - Cash Flow

In Section IV above you calculated the violator's net cash flow. The purpose of this
calculation is to determine what amount, if any, the individual might be able to contribute towards
a penalty payment, from readily available funds. In assessing the portion of this amount that might
go towards a penalty, it is a good idea to set aside an "emergency" or contingency allowance to cover
the violator's unexpected expenses for the year ahead. This contingency amount should equal five
to fifteen percent of the violator's personal expenses. The percentage you select should be based
on the violator's income, as compared to national or local medians and family size. Use a higher
contingency percentage for lower income households. In our example, Tank's income of $59,009
is approximately 170 percent of median income for a family of five in Iowa (his home state). We
therefore might set aside a lower contingency allowance (five percent of income), because his
income is relatively high.

• Pre-tax cash flow. On Line 65, enter the amount from Line 41 of this
worksheet.

•	Contingency percentage. On Line 66, enter the percentage of expenses for
the violator's contingency. We determined, based on his income, that Tank's
contingency should equal five percent of his personal expenses.

•	Contingency amount Multiple the percentage on Line 66 by the value on
Line 37 for the proprietor's contingency amount. Enter this total on Line 67.
Tank's contingency equals $1,854 ($37,087 x .05).

•	Available pre-tax cash flow (net of contingency). Subtract Line 67 from Line
65 for the proprietor's available cash flow. Enter this total on Line 68.
Tank's pre-tax cash flow equals $20,068 ($21,922 - $1,854).

•	Tax adjustment Adjust for taxes by multiplying pre-tax cash flow on Line 68
by one minus the maximum individual tax rate (1 - 0.33 =* 0.67). Enter the
result on Line 69.

•	Non-cash deduction tax benefits. Add together the amounts on Lines 13,14,
25, 30 and 32. Multiply the total ($4,795) by the tax rate (0.33) and enter the
result on Line 70.

•	After-tax cash flow. Add together Lines 69 and 70, and enter the result on
Line 71. ,

From these calculations, we see that Tank can provide approximately $15,028 in after-tax
cash to fund a penalty (($20,068 x 0.67] + [$4,115 + 680] x 0.33).

6-12

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Part B - Net Worth Assessment

The next step is to determine if the violator might be able to pay a penalty through the sale
of some assets or through assuming additional debt. In Part E of Section V above, you calculated
the sole proprietor's net worth. At issue here is what portion of this net worth can be used to fund
a penalty payment. Obviously, lower income individuals, or individuals with fixed incomes will be
less able to replace assets or to borrow funds. As a general rule of thumb, low income, unemployed,,
or retired individuals should maintain an liability-to-asset ratio of 0.5 to 0.6. If the individual's
liability-to-asset ratio is above this value, financing a penalty through a loan should not be
considered. As an individual's income rises, the baseline liability-to-asset ratio can be relaxed
somewhat, to perhaps 0.7 to 0.8 for younger, high income violators that can pay off debt over a
longer period.

In our example, Tank is 48 years old and his income is about 170 percent of the median for
a Iowa family of five. Based on this information, we might select a baseline liability-to-asset ratio
("target ratio") of 0.7 for this violator. Our selection means that any asset liquidation or new debt
that Tank acquires to fund a penalty should not cause his liability-to-asset ratio to exceed 0.7. If
the violator's current liability-to-asset ratio falls below this target, excess assets may be available.
In our analysis, we calculate a dollar figure for this potential excess.

You must also consider what portion of the violator's income is applied toward current debt.
The criterion generally applied by banks and other lending institutions is that an individual's total
debt (mortgage and other housing obligations, credit cards and other loans) should not exceed 36
percent of gross income. Tank's percentage of personal -debt to income (on Line 38 of this
worksheet) is 17 percent, indicating that he probably has additional debt capacity.

Below, we summarize information about our sample case with Russ T. Tank.

•	Net worth. Enter on Line 72 the net worth figure from Line 63 above.

Tank's net worth is $277,559.

•	Target liability to asset ratio. Enter on Line 73 the target ratio you will apply
to this violator, based on age and income. Our target for Tank is 0.7.

•	Target assets. We next want to determine the necessary assets for this
violator, based on his or her target liability-to-asset ratio. To determine this
dollar amount, divide Line 62 (Total liabilities) by Line 73 (Target ratio).

Tank's liabilities equal $359,961. If we divide this by 0.7 we get a dollar
figure of $514,230, which represents the amount of assets Tank should
maintain. Enter this percentage on Line 74.

•	Available assets. We next want to estimate the violator's available assets,
that is, the value of assets that might be available for environmental costs.

We find this value by subtracting the violator's target assets from his or her
actual assets. For Tank, subtract Line 74 ($514,230) from Line 54
($637,520). The result is $123,290. Enter this on Line 75.

6-13

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• Percentage of debt payment to annual income. Divide Line 38 on this
worksheet by Line 36 to determine the portion of the proprietor's income
that goes to debt. Enter this percentage on Line 76. Tank's personal debt
to income ratio is 0.17 or 17 percent ($9,769 + $59,009).

The cash flow and net worth calculations give us an estimate of the funds available for a
penalty. Again, it is important to point out that this analysis requires a measure of judgment as to
the violators "ability to pay." We have tried to provide enforcement staff with a framework for
assessing a sole proprietor's cash flow and net worth; however, the guidelines are general and are
not meant to serve as "hard-and-fast" rules.

6-14

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Individual Financial Data Request Form

This form requests information regarding your personal financial status. The data will be used to evaluate
your ability to pay for environmental clean-up or penalties. If there is not enough space for your answers,
please use additional sheets of paper. Note that we may request further documentation of any of your
responses. We welcome any other information you wish to provide supporting your case, particularly if
you feel your situation is not adequately described through the information requested here.

Certification

I declare that this statement of assets, liabilities, and other information is true, correct, and complete to

the best of my knowledge and belief.



Signature

Date

jAjyo / . 	





ir^ame: R\A5t>€LL.T ¦ TAnJ£L-

Age: 48

Address:

1 32- WASHIM6T0U



AUVORT>; IA



1

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PART I. BACKGROUND INFORMATION

1. MEMBERS OF HOUSEHOLD (List the head of the household and all persons living with you)

¦. Name

Age

Relationship to Head
of Household

Currently
Employed?

RUV>£U_ T. "TANK-

48

CO - K^-A-D

ves

LfsNiOfcA ?. TANKL

A8

CO -

ves



IT



NO

TAV TANK.

IS

20N

Mn

TANAJ/W TANK.

10

T) AU.£irM T£i£-

N0

















2. EMPLOYMENT (List aO jobs held by persons in house bold)

Name

Employer

Length of
Employment

Annual
Salary

RUt6 Tan t-

S6LP-g n PUTJfO A<> STAT 10 Ni

v&s

no -fiAed
So-lcx^M

l.£mo£a tank.

AUV0E.T5 VtoSPlT/M-

t yzs

$1 i ,4oi

SRu<:£ TAKlC.

fUL-L- OP 6-AS

2 SUW&ZS

* Z.500

























2

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PART n. CURRENT LIVING EXPENSES

Please list personal living expenses which were typical during the last year and indicate if any of these values are
likely to change significantly in the current year. Please do not include business expenses. If you are the owner
of an operating business, please attachment any available financial statements.

I

Amount

Period of Payment (check one)

For Agency Use Only

Expense

Weekly

Monthly

Quarterly

Yearijp

A. Living Expenses













1. Rent













2. Home maintenance

IOO









400

3. Auto fuel maintVother transp.

45

y







.2.33*

- 4. Utilities

a. Fuel (gas,oil,wood,propane)

15*



/





1.900

b. Electric

1-1



l/





Sfef

c. Water/sewer

2+









aw

d. Telephone

13a









/, srt

5. Food

91

/









6. Gothing, personal care

433









s,m

7. Medical costs

5i9









A.0J5

B. Debt Payments













1. Mortgage payments

52.0









(f.3.40

2. Car payments

22k



y





3 ,-U9

3. Credit card payments

25





/



too

4. Educational loan payments













C. Insurance













1. Household insurance

4-1









11*2

2. Life insurance

10 5





/



«/ao

.3. Automobile insurance

I j (cDO









l.bOO

4. Medical insurance











TU>

D. Taxes













L. Property taxes







y



!.05(,

2. Federal income taxes

5,399









( jL&rarrt)

3. State income taxes

l.0?9







y

1 019

4. FICA

%2D









SAO

E. Other Expenses













1. Childcare







/





2. Current School tuition/expenses

4O0





y



l.uoo

3. Legal or professional services

+50







v/

1/50

4. Other (itemize on separate page)













Total Current Exoenses













3

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PART m. NET WORTH

I. BANK ACCOUNTS (Checking, NOW, Savings, Money Market, etc.)

Name of Bank or Credit Union

Type of Account

Current Balance

FlR5T ALVOfcD

CHBC kilMGr

U,A/9



it

/, poL

it »•

SA\; ik)6-£>

5, 4jAO







For Agency Use Only - Total Current Balance in Bank Accounts

19,301

'

2. INVESTMENTS (Stock, Bonds, Mutual Funds, Options, Futures, CD's, Real Estate Investment Trusts
(REIT), etc.)

Investment

Number of Shares or Units

Current Market Value

CD (PlZST Alvo^d^

/

$ ID,000

H II 11

/

10, OOO













For Agency Use Only - Total Current Market Value of Investments

3.0,000



3. RETIREMENT FUNDS AND ACCOUNTS (IRA, 401(k), Keoagh, vested interest in company retirement
fund, etc.)

Description of Account

Estimated Market Value













For Agency Use Only - Total Estimated Market Value of Retirement Funds and
Accounts



4. LIFE INSURANCE POLICIES

Policy Holder

Issuing Company

Policy Value

Cash Value

tanC

MUTU*t_ Of OMAI+A

IS,COO

4,800

tan^_

M " «¦

ID,OOO

3, COO

















For Agency Use Only - Total Value of Life Insurance Policies

J. 300

4

-------
S. VEHICLES (Can, Trucks, Motorcydes, Recreation Vehicles, Motor Homes, Boats, Airplanes, etc.)

Model

Year

Estimated Market Value

CHevy 4*4

19? 0

* I4-.0OO

UNCOUNJ CONT-

19%%

' 3, OOO

escoer

19

A, COO

For Agency Use Only - Total Estimated Market VaJue of Vehicles

^.00 O



6. PERSONAL PROPERTY (Household Goods and Furniture, Jewelry, Art, Antiques, Collections, Precious
Metals, etc. Only list items with a value greater than $500.00)

Type of Property

Estimated Market Value

Pu£.nMTU££;

12, coo



5, ooo













For Agency Use Only - Total Estimated Market VaJue of Personal Property

I"?,OOO

7. REAL ESTATE (Land, Buildings, Land with Buildings)

Location

Description of Property

Estimated Market Value

133 V\)A5Hl^6TO^

2 Ace£5. , HCU«2r6. GA£A66

1-8, ooo



















For Agency Use Only - Total Estimated Market Value of Real Estate

TO,OOO

8. OTHER ASSETS

Type of Asset

Estimated Market VaJue





















| For Agency Use Only - Total Other Assets



5

-------
9. CREDIT CARDS AND LINES OF CREDIT

Credit Card/Line of Credit (Type)

Owed To

Balance Due

A uvord S+-U ceeoiT LfMB

AUV0£D S-rL

io,cco

piscovee. casjd

S8AR.S

1,058

A WORD ClTy -Vl^A

AlmoRd "S*-U

3,596

PlR6T AM££\CA^ visa

AN\££lCA^ "BAMC

2.3 91-













For Agency Use Only - Total Balance Due on Credit Cards and Lines of Credit

j*,cui



10. VEHICLE LOANS (Can, Trucks, Motorcycles, Recreation Vehicles, Motor Homes, Boats, Airplanes,
etc.)

Vehicle (Model and Year)

Owed To

Balance Due

CH6\IV 4-x4 (Mlo)

FlC^ALv/AED SH-

s,boo

UlNCOUlO COMT. C\93&)

n

3,9(oO







For Agency Use Only - Total Balance Due on Vehicle Loans

/a, 5fco

1

11. FURNITURE AND HOUSEHOLD GOODS LOANS:

List Item

Owed To

Balance Due

LIMIN&ROOM Pu^NJlTue^

HAHN '*> Pue^iTue^

3,923













For Agency Use Only - Total Balance Due on Furniture and Household Goods
Loans

3,7.23

12. MORTGAGES AND REAL ESTATE LOANS

Type of Loan

Owed To

Property Secured
Against

Balance Due

HOMfc M0e,T7-rA£H=:

ALvJOgD S*-L_

132. vslASHiMttTOfJ

3 a,%o

























For Agency Use Only - Total Balance Due on Mortgages and Real Estate Loans

33.KeO

6

-------
13. OTHER DEBT (Amounts due to individuals, Fixed obligations, Taxes Owed, Overdue Alimony or Child
Support, etc)

Type of Debt

Owed To

Balance Due

P£R50 LOAn!

AUFE-eO t.

¦19,035

























For Agency Use Only - Total Balance Due on Other Debt

19,039

7

-------
PART IV. ADDITIONAL INFORMATION

Please respond to the following questions. For any question that you answer "Yes," please pr<
additional information on. separate pages or at the bottom of this page.

QUESTION

YES

NO

1. Do you have any reason to believe that your financial situation will change
during the next year?

X



2. Are you currently selling or purchasing any real estate?



X

3. Are you involved or affiliated with any other sole proprietorships, parterships
or corporations?



X

4. Is anyone (or any entity) holding real or personal property on your behalf
(e.g., a tmst)?



X

5. Are you a party in any pending lawsuit?



X

6. Have any of your belongings been repossessed in the last three years?



X

7. Are you a Trustee, Executor, or Administrator?



X

8. Are you a participant or beneficiary of an estate or profit sharing plan?



v -
A

9. Have you declared bankruptcy in the last seven years?



'I

10. Do you receive any type of federal aid or public assistance?



X

MY 0/vfLT> ") OF' ABOUT

^,000.

8

-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Section I. General Information

.1.

Violator (Business): ^Tank's fuW (Ssso-tine.

2.

u

Address: icO Mack Avt •



A;\v0^rd; X*

3.

Proprietor: T. 'T^nlsL.

4.

Principal business activity and product or service (Schedule C, Item A):



GdSO^riC SC.*" V^GL 'srfd.'K OT\—

5. Original penalty amount



Section II. Financial Information

6. Tax returns and schedules

Year
Prepared

fCYYYy 1 04O j A , <£nci E.

19??

•• 	

1990

V( H \» •* ' " v« ^ "

1991





















7. Financial Statements

Period(s) covered



'Xnccnnne ^rc&emersf "Bslsncx -fW

|C?S9

1, v\ " n "

\990

W ^ v.*. \* \* v* v*

I99I

, X^ciivArLie^ h'na^oW Ds^Va. 2jz.Quui.-Srt-

\ 792-





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SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Section IL Financial Information (continued)



8. Other information on violator or industry:





C.cn~nrncm- 51ZC Sr+Q-fepne^rdr Serv
-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

r

Section IIL Ownership and Operating Affiliations

Additional business concerns (check and answer where applicable)

Yes

No

9. Is this corporation affiliated with any other business concerns (e.g.,
corporations, partnerships, sole proprietorships)



X



10. If Yes, provide the following information:

Name of entity

Type of entity

Relationship and documents
available



















11.	Summary: Discuss possible expansion of Ability to Pay analysis

-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Section IV - Income



Part A. Business Income





12. Business income





(from LineN 12 on 1040)



S 33,20*





13. Depletion

+



(1040 Schedule C, Line 12)



$ O





14. Depreciation and/or Amortization

+



(1040 Schedule C, Line 14)



$ 4j U 5





15. Total business income

=







$ 42,323



Part B. Personal Income





16. Wage income





(Line 7 on tax form)



$ 11,401





17. Taxable interest income





(Line 8a on tax form)





1



18. Tax-exempt interest income





(Line 8b on tax form)



$ 0





19. Dividend income





(Line 9 on tax form)



$ 0





20. Alimony received





(Line 11 on tax form)



$ 0





21. Total IRA distributions





(from tax form: if Lines 16a and 16b are both greater





than zero, enter the amount on 16a; if Line 16a is zero





and line 16b is positive, enter the value on Line 16b)









$ 0





22. Total pensions and annuities





(from tax form: if Lines 17a and 17b are both greater





than zero, enter the amount on 17a; if Line 17a is zero





and line 17b is positive, enter the value on Line 17b)









$ 0





23. Total social security





(Line 21a on tax form)



$ . 0



-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

24. Total income or (loss) from rental properties or
royalties (Schedule E of tax form, Line 22)

25. Depreciation or depletion on rental property

(Schedule E of tax form, Line 20 total all properties)

26. Partnership/S corporation income or (loss)
(Schedule E of tax fonn, Line 31)

27. Estate and trust income or (loss)
(Schedule E of tax form, Line 36)

28. REMIC income or (loss)

(Schedule E of tax form, Line 38)

29. Farm rental income or (loss)

(Schedule E of tax form, Line 39)

30. Depreciation on farm rental property
(Form 4835, Line 13)

31. parm income or (loss)
(Line 19 on tax form)

32. Depreciation on farm property
(Schedulie F of tax form, Line 17)

33. Capital gain or (loss)

(Lines 13 plus 14 on tax form)

34. Other gains or (losses)
(Line 15 on tax form)

35. Total personal income
(add Lines 16 through 34)

36. Total income

(add Lines 15 and 35)

$ 59,009

$	0

$ 1bjbVc

$ 0

$ o

$ 0

% o

$ i?%0

$ 0

s 0

$ 2,340

s o

$ 0



-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

$ 37,02?

$

$JZ\)C}22

Expense Evaluation

Expense Category

Amount

Possible
reduction

Justification for reduction









































40. Total possible reduction in expenses jl ^
(Sum the possible reductions): T CJ

41. Adjusted pre-tax cash flow:
(Line 39 + Line 40)

Section V. Net Cash Flow

37. Total annual living expenses, net Federal Income Taxes
(convert expenses from Part II of Financial Data
Request forrri to annual values and sum; ignoring Line
D.2)

38. Total annual debt payment

(Part II of Individual Financial Data Request form,
sum entries in section "B. Debt Payments")

39. Pre-tax cash flow

(subtract Line 37 from Line 36)

$ =2 l} 9<2*2.

-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Section VL Net Worth
Part A. Business and Personal Assets

$ 19,301
$ .30,000

$ o

$ •fr.BQO
S 34,000
$ I?,000

S	?8,O0P

S	Q
S |k(gt 101
$

$	520

42. Bank accounts (Part III of Individual Financial Data Request
form, total from III.l)

43.

Investments (Part III of Individual Financial Data Request form,
total from III.2)

44.

Retirement funds and accounts (Part III of Individual Financial
Data Request form, total from III.3)

45.

Life insurance policies (Part III of Individual Financial Data
Request form, total from III.4)

46.

Vehicles (Part III of Individual Financial Data Request form,
total from III.5)

47.

Personal property (Part III of Individual Financial Data Request
form, total from III.6)

48.

Real estate (Part III of Individual FinancHal Data Request form,
*.otal from III.7)

49.

Other assets (Part III of Individual Financial Data Request
form, total from III.8)

50. Total personal assets (sum Lines 42 through 49)

51. Business assets (from Sole Proprietorship balance sheet)

52. Total assets (Line 50 + line 51)

-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Section VL Net Worth (continued)

Part B. Asset Evaluation

Asset and Use

Book Value

Estimated
Market Value

Value
Difference









































53. Total estimated excess value of assets

$ 0

54. Revised asset total
(Line 52 + Line 53)

$ k>3?yS20

Part C Business and Personal Liabilities

55.

Credit cards and lines of credit (Part III of Individual Financial
Data Request form, total from III.9)

56.

Vehicle loans (Part III of Individual Financial Data Request
form, total from III.10)

57.

Furniture and household goods loans (Part III of Individual
Financial Data Request form, total from III.ll)

58.

Mortgages and real estate loans (Part III of Individual Financial
Data Request form, total from III. 12)

59.

Other debt (Part III of Individual Financial Data Request form,
total from III. 13)

$ 19/035

$ 3,9,23

$ 32,7^0

$ 12,50? O

$ IT-,00.1

60. Total personal liabilities (sum Lines 54 through 59)

$ ?5;299

61. Business liabilities (from Sole Proprietorship balance sheet)

$;n-f

62. Total liabilities (Line 60 -ft Line 61)

S 359,9k I

-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Section VL Net Worth (continued)
Part D. Net Worth Calculation

63. Net Worth (subtract Line 62 from Line 54)

64. Liability-to-Asset Ratio (divide Line 62 by Line 54)

t 2?7,S59

5(o %

Section VII. Case Disposition
Part A, Cash Flow

65. Pre-tax cash flow (from Line 41)

66. Contingency percentage

(enter the contingency percentage for expenses)

67. Contingency amount (multiply Line 66 by Line 37)

68. Available pre-tax cash flow net of contingency
(subtract Line 67 from Line 65)

69. Tax adjustment (Line 68 x 0.67)

70. Non-cash deduction benefits

71. Estimated after-tax cash flow (Line 69 + Line 70)

$ I j S'Z'X

S 15,023

$ 2.0,0k*

$ i3,44(o

$ 1,354

5 %

$21,922

-------
SOLE PROPRIETORSHIP
EXTENDED ABEL ANALYSIS

Part B. Net Worth Assessment





72. Net Worth (from Line 63 above)









$^>,559





73. Target Liability-to-Asset Ratio









70 %





74. Target assets (divide line 62 by Line 73)









$ 514, 230





75. Available assets (subtract Line 74 from Line 54)









$ 12.3,390





76. Percentage of debt payment to annual income





(divide Line 38 by Line 36)



1? %







Analyst's Name

r>a,e s/ia./?>-

-------