Vail Daily column: Every self-employed scenario is different
Death and taxes — you know how the saying goes. For all of us, one of those two is quickly approaching. Unless you plan to file extensions, your income taxes are due to Uncle Sam in about six weeks.
Gathering and organizing all of the necessary documentation to file your income taxes can be an arduous task. The same can be said for going through the mortgage application process and applying for a loan. Documentation for filing your income taxes is pretty much the same documentation I need to obtain for the mortgage application.
Both processes go hand in hand, and the scenario is even more intertwined with borrowers who are self-employed. Underwriting a self-employed borrower’s tax returns in order to derive an accurate figure for their annual and monthly income is a complex task. For better or worse, the net numbers that show on line 22 or 37 of a personal 1040 tax return is often not the number I will use for the annual and monthly income on the mortgage application.
Annual tax returns
Continually, I urge self-employed borrowers to meet with me so that I may review their tax returns for accurate income calculations. Before annual tax returns are filed with the IRS is the best time to go through this exercise. Prior to filing the returns is the point in time when specific adjustments can be made to either show more income on the tax returns or possibly to take more deductions and lessen the tax payments. Do note that I highly recommend adjustments be made in consult or in conjunction with a borrower’s accountant or bookkeeper.
Please do not misconstrue that statement. In no way am I implying that anything illegal, or not in accordance with IRS rules and regulations, should be done. I am simply stating that just because a borrower may technically be eligible for a specific deduction does not mean that they must take the deductions. Less deductions taken mean more income shown, and that may help borrowers qualify for their specific financing needs. Vice versa is also true. A borrower may show ample income to qualify for their specific financing need and thus may be able to maximize every deduction they are eligible for.
But once the returns are filed and in with the IRS it is difficult to go back and make any retroactive adjustments to the returns to try and squeak out more income for qualification. In many cases, the difference between a self-employed borrower qualifying for, or being denied, a specific loan is a very small amount of annual income. When a tight scenario presents itself, it can be a frustrating experience for everyone involved with the transaction.
To site some specific examples: most depreciation and home office expenses can be automatically be added back in to the income calculation. Therefore, those deductions generally do not have a negative impact on income. However, deductions taken for meals, mileage, marketing and advertising, telephone and internet cannot be added back in to the income calculation. For example, simply because a borrower incurred $5,000 over the course of a business year in meals and entertainment does not mean that the full $5,000 must be deducted. The borrower could elect to deduct a smaller amount and pay more in taxes because more income is reported. The more income that is reported, the higher the borrowing capacity.
Again, every self-employed scenario is different and unique. But every self-employed scenario requires a meticulous review from a seasoned mortgage professional in order to determine borrowing capacity.
William A. DesPortes of Central Rockies Mortgage Corp. can be reached at 970-845-7000, extension 103, and firstname.lastname@example.org.