Self employed income analysis… probably one of the harder things to get your mind around if you work on the mortgage industry. However once you get the hang of “the where, what, and why” on the common business return, it gets much easier. FNMA All Regs and FHLMC All Regs outline their expectations for calculating income for different forms of self-employed borrowers. The trick is they don’t tell you where to find it on the borrower’s tax returns!
In part one of this series, let’s start with one of the more basic form of self-employed borrowers, the sole proprietor or 1099 independent contractor who uses the Schedule C form. First let’s give you the “where and what “ and in the next article we can talk about why!
FNMA All Regs B3-3.2.1.04
The lender made need to make certain adjustments to the net profit on Schedule C to arrive at the borrower’s cash flow. Schedule C may include income that was not obtained from the profits of the borrower’s business. If the lender determines that such income is nonrecurring it should adjust the borrowers cash flow by deducting the nonrecurring income
Nonrecurring and any exclusion for meals and entertainment expenses reported by the borrower must be deducted from the cash flow. The following items must be added back to the cash flow analysis : depreciation, depletion, business use of home, amortization, and casualty losses
FHLMC All Regs SSG Vol 1 37.13 Part B
The Seller’s calculation of a self-employed Borrower’s average monthly income must be based on a review of the Borrower’s complete individual federal tax returns (Form 1040) including W-2’s and K-1’s (if applicable) as well as the Borrower’s complete business tax returns (Forms 1120, 1120S and 1065), when applicable. The Seller must analyze the tax returns and provide a written analysis of the Borrower’s self-employed income on Form 91 or a comparable form. Non-cash items such as depreciation, depletion and amortization may be added back to adjusted gross income for the purpose of determining qualifying income. Documented nonrecurring losses, such as casualty losses, can also be added back to the adjusted gross income, as well as loss carry-overs from previous tax years.
So now you have the “words”, where are those boxes on the IRS form Schedule C?
1) Line 6 is income from another source, as FNMA stated you have to determine if this is recurring or nonrecurring (the same way you do for any business, 2 years back and potentially three years forward) So this one is a bit tricky, you have to SUBTRACT if it is a POSITIVE number OR ADD back in a NEGATIVE number. The trick to this number is the question “is this income or loss recurring AND can I document that!”.
2) Depletion – Line 12
3) Depreciation – Line 13 and Line 44a (line 44A contains some depreciation for mileage don’t the full amount)
4) Meals and entertainment- Line 24B must be subtracted from cash flow not added!
5) Business use of home – Line 30
6) Amortization and Casualty losses – Page 2 Part V which then pushes over to line page 1 line 27A
As mentioned this is part one of three quick articles on cash flow review of self employed articles. Here is what we will discuss in the next parts of this series!
Part 2 – Why do you add or subtract those items to the cash flow?
Part 3 – Where are those boxes on a 1065 partnership?
Part 4 – Where are those boxes on the 1120S and 1120 returns?
We hope this series of four articles will give you a better understanding of self employed borrower’s income. We would also like to mention we have built a free tool that can calculate all these forms of income with a bit of data entry and the click of a mouse! Fast, documented, and accurate income every time and its FREE! Check out www.blueprintio.wpengine.com to see it in action and get your free account today!