TIP OF THE DAY- FHA SELF EMPLOYMENT INCOME
TIP OF THE DAY: FHA - SELF-EMPLOYMENT INCOME
(A) Definition Self-Employment Income refers to income generated by a business in which the Borrower has a 25 percent or greater ownership interest. There are four basic types of business structures. They include:
· sole proprietorships;
· limited liability or “S” corporations; and
(1) Minimum Length of Self-Employment The Mortgagee may consider Self-Employment Income if the Borrower has been self-employed for at least two years. If the Borrower has been self-employed between one and two years, the Mortgagee may only consider the income as Effective Income if the Borrower was previously employed in the same line of work in which the Borrower is self-employed or in a related occupation for at least two years.
(2) Stability of Self-Employment Income Income obtained from businesses with annual earnings that are stable or increasing is acceptable. If the income from businesses shows a greater than 20 percent decline in Effective Income over the analysis period, the Mortgagee must downgrade and manually underwrite.
(C) Required Documentation
(1) Individual and Business Tax Returns The Mortgagee must obtain complete individual federal income tax returns for the most recent two years, including all schedules. The Mortgagee must obtain the Borrower’s business tax returns for the most recent two years unless the following criteria are met:
· individual federal income tax returns show increasing Self-Employment Income over the past two years;
· funds to close are not coming from business accounts; and
· the Mortgage to be insured is not a cash-out refinance.
In lieu of signed individual or business tax returns from the Borrower, the Mortgagee may obtain a signed IRS Form 4506, Request for Copy of Tax Return, IRS Form 4506-T, Request for Transcript of Tax Return, or IRS Form 8821, Tax Information Authorization, and tax transcripts directly from the IRS.
(2) Profit & Loss Statements and Balance Sheets The Mortgagee must obtain a year-to-date Profit and Loss (P&L) statement and balance sheet if more than a calendar quarter has elapsed since date of most recent calendar or fiscal year-end tax return was filed by the Borrower. A balance sheet is not required for self-employed Borrowers filing Schedule C income. If income used to qualify the Borrower exceeds the two year average of tax returns, an audited P&L or signed quarterly tax return must be obtained from the IRS.
(D) Calculation of Effective Income The Mortgagee must analyze the Borrower’s tax returns to determine gross Self-Employment Income. Requirements for analyzing self-employment documentation are found in Analyzing IRS Forms. The Mortgagee must calculate gross Self-Employment Income by using the lesser of:
· the average gross Self-Employment Income earned over the previous two years; or
· the average gross Self-Employment Income earned over the previous one year.