Written By: Joan Ewing
Hello All – I hope the blog on Self-Employment is informative and it is helping to answer questions you may have. This week we will discuss Corporate Tax Returns, “S” Corp Tax Returns and Partnerships.
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Corporate Tax Returns seem to be the most frightening to everyone. I do not know one processor or underwriter who likes Corporate Tax Returns. Many borrowers set up a Corporation to protect their personal assets in case of bankruptcy or lawsuits. A Corporation is a state-chartered business that is owned by the shareholders. The shareholders could be as few as 1 or as many as millions. Compensations to the officers of the corporation are based on the percentage of ownership and are reflected on the shareholder’s personal tax return. If the percentage of ownership of is not shown on the tax returns, this information must be obtained from the corporation’s accountant. After the adjusted business income is obtained, it should be multiplied by the borrower’s percentage of ownership.
When analyzing the corporate tax returns, the following adjustments must be made:
1. Depreciation and Depletion – must be added back to after-tax income.
2. Taxable Income – is the corporation’s net income before federal taxes. The income must be reduced by the tax liability.
If the corporation operates on a fiscal year rather than a calendar year, an adjustment must be made to relate corporate income to the individual’s tax return.
In order that the corporation does not suffer from the negative impact of the withdrawal of cash – an accountant’s letter should be obtained stating the withdrawal of cash from the corporation will not have a negative impact.
“S” Corp Tax Returns – An “S” Corp is generally a small start-up business with gains and looses passed on the stockholder in proportion to each stockholder’s percentage of business. The owners receive a W-2 form for the income and it is taxed as personal income.
The compensation of officers line on the IRS 1120S is transferred to the borrower’s IRS form 1040. Both depreciation and depletion may be added back to the income in proportion of ownership. Again ask for verification from the accountant that the withdrawal of cash from the corporation will not have a negative impact on the corporation.
Partnership Tax Returns - A partnership is formed when two or more individuals form a business and share in the profits, losses and responsibility for running the business. Each partner pays taxes on the share of the partnership’s net income.
General and Limited Partnerships report income on IRS Form 1065; this form must be reviewed by the lender to ascertain the strength of the business. The partners share is report on Schedule E of the 1040. Depreciation and depletion may be added back to income in proportion of ownership. However, losses in the business must also be proportionally subtracted from the income. In order to assess the impact of taking cash out of the business – again ask for an accountant’s letter as to strength of the business.
So – that is all there is to Self-Employment. I have been receiving many questions from processors, former underwriters and those who want to start underwriting. The questions range from how do I get started to I need to hone my skills – so next week, I will be discussing how I feel you can get started as an underwriter. Of course, it will be my opinion; however, I feel it will give you a good starting point.
About The Author
Joan Ewing - As an active FHA DE Underwriter for the past 15 years, Joan Ewing is a proud NAMP® Certified Ambassador Loan Processor (NAMP®-CALP). Joan brings years of FHA Government experience to her writings, letting her readers tap into her underwriting knowledge base. If you would like to become a writer for NAMP®, please email us at: firstname.lastname@example.org.