After years of working in underwriting when you look through enough loans it becomes easier over time to recognize a borrower’s income type.  However there are those income types that are rare and when you run across them can take you out of your underwriting rhythm.  One of those income types is the statutory employee.  They stand out because their pay stubs will have the normal SSA, Medicare, and health insurance deductions, but have no deductions for federal, state, or local taxes removed and they will generally have filed Schedule C tax forms.

A first glance you might think these borrowers are self-employed because you will see their w-2 income transferred to a Schedule C.  Their schedule C will look pretty much identical to any other sole proprietor or independent contractor.  But don’t fall into this trap, they are in fact employees and will require all the same documentation an employed borrower does (pay stubs, verbal VOE, and W-2).

What is a statutory employee

Wikipedia gives a really good underwriting overview of this employment type:

A statutory employee is an independent contractor under IRS common law that is treated as an employee, by statute, for tax withholdings. For a standard independent contractor, an employer cannot withhold taxes, as this would change the independent contractor relationship into an employer-employee relationship. Statutory employees are also permitted to deduct work-related expenses on Schedule C instead of Schedule A in the United States tax system. As a result, they are allowed a greater tax deduction for business expenses than standard employees, as Schedule C expenses are not subject to the 2% adjusted gross income threshold as seen with Schedule A.

Examples of borrowers who will be statutory employees

  • A life insurance agent whose main business is life insurance and annuity for one company
  • Someone who works from home on materials an employer supplies, that must be returned and for which the employer gives work specifications
  • A traveling salesperson who turns in orders from wholesalers, retailers, contractors, hotels, or restaurants, either for resale or business use. Work performed must be the principal business activity of the employee
  • A driver distributing non-dairy beverages, meat, vegetable, fruit, or baked goods; or who picks up laundry, if he acts as an agent or is paid by commission.

How to calculate income for the statutory employee

The good news here is that working with a statutory employee requires almost all of the same items as working with a commissioned borrower. Here is the step by step to get the correct income.

Step 1: Determine the amount of expenses to deduct

Calculate the expenses that must be deducted from the income.  These are found on the Schedule C versus the Schedule A that most commissioned borrowers have.

  1. Start with Line 28
  2. Subtract Line 12 depletion
  3. Subtract Line 13 depreciation
  4. Subtract Line 27a ONLY if you find one-time expenses, amortization, or causality loss listed on page 2
  5. Add Line 24B Meals & Entertainment
  6. Subtract Line 44a mileage depreciation only
  7. Equals Total of expenses


SCH C Example

tax form for statutory employee income

 Step 2 analyze the gross trending income

Calculate the average monthly income is per year to confirm stable income trend.

  1. Take YTD gross sales divided by number of months elapsed in year to get monthly income
  2. Take 2015 W2 income divided by 12 (NOTE these borrowers may have more than one W-2 source)
  3. Take 2015 W2 income divided by 12

Once you have this trending income confirmed as stable, determine what length of time to average, for example YTD only, or YTD + 1yr, or YTD + 2yr.

Step 3 Determine the final income

There are two prevailing thoughts on how to determine the final income, I will show you both, method two is the more conservative method, but both will give you a properly qualified income analysis.

statutory employee income analysis

 Method 1

1) Add up year to date commissions + From 2015 W-2 SCH C Line 1 + 2014 W-2 From SCH C Line 1
2) Subtract 2015 and 2014 Total Expenses found on Schedule C
3) Arrive at total income
statutory income analysis method one

 Method 2 (more conservative method)

1) Add up year to date commissions + From 2015 W-2 SCH C Line 1 + 2014 W-2 From SCH C Line 1
2) Determine the historical percentage of expense the borrower has deducted in previous 2 years
3) Subtract the historical percentage of expense from the total income
4) Arrive at total income

method two for statutory employee income analysis