Loan Officer Training - 11/14/2024 - Analyzing Self-Employed Borrower Income: C-Corporations - Loan Officer Training with The Mortgage Calculator

Episode Transcript
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Restream recording Nov 14, (00:00):
So, uh, Let's get right into it
here, um, in analyzing selfemployed borrower income for a C
corporation.
Excuse me.
So, what exactly is a Ccorporation, right?
A C corporation is a legalentity that exists separate from

(00:23):
owners who are shareholders,right?
They own stock in the company.
Um, Um, they do not actually ownthe company.
Uh, therefore, uh, should benoted that stockholders are not
personally, personally liablefor the debts incurred by the
corporation.

(00:44):
Please note that there should bearticles in the corporation
filed with the secretary ofstate.
Profits from the corporation aredistributed to shareholders via
dividends.
Now it could be also that therecould be W 2 wages involved, but

(01:05):
how those are going to beconsidered, if it's going to be
considered self employment.
Or W 2 earnings is going todepend on if the borrower owns
100 percent of the stock, right?
That's the only, uh, that's themain point that I wanted to

(01:27):
state that is the big differencebetween an S corp and a C corp.
Uh, for a C corp, uh, for, for aC corp borrower, To be
considered self employed, theborrower needs to own a hundred

(01:47):
percent of the stock of thecorporation.
And they also need to own ahundred percent of the stock of
the corporation in order to use,oops, what happened?
Sorry about that.
In order to use any.
Of the income or to have anylosses counted against them,

(02:09):
against their income.
Now, this is probably the mostimportant point.
So let me, and I'll touch baseon it a little bit further.
But with that being said, pleasenote that again, touching back
on the point borrowers whoreceived W 2 income are still
considered employees if they ownless than 100 percent of the

(02:32):
stock, uh, and losses arelimited.
Okay.
To the amount of investment incompany stock, right?
Now notice, note that rightthere, right?
That's very important pointsbecause I've gotten into this,
um, discussion in many fileswhere the, um, borrower may own

(02:55):
a certain percentage of thestock.
Let's say they own at least 25percent or more.
And for an S corporation, 25percent is the benchmark.
Okay.
at which a borrower would beconsidered self employed.
But that is not necessarily thecase for a C Corp, at least not
when you have a Fannie Mae orFreddie Mac or any other agency

(03:20):
loan.
Now, if it's a non QM loan, Ihave seen guidelines where 25%
of an S Corp or owns 25 percentof the stock of a C Corp is
considered self employed, butthose were exceptions to the

(03:41):
rule, right?
I think, uh, and all the dealsI've done, I think I ran into
one, um, guideline for oneinvestor that had that in the,
um, you know, in theirguidelines on how to interpret
self employment, right?
But as for typically, if youlook at any of the training and

(04:03):
guidance on income, It is goingto state that for the income to
be able to be used by the barfor the C corpse income to be
able to be used by the borrowerand for the losses, just as
important for the losses to beconsidered.
against the income of theborrower, the losses of the

(04:24):
corporation, the borrower has toown 100 percent the stock of the
company.
And then the other, um, point isgoing to be that their losses
typically are limited to theamount of stock that they own.
So trying to attribute all thecorporate losses To the

(04:45):
borrower, they own a hundredpercent of the corporation
stock, you know, um, is thatusually something that is going
to happen?
So again, this is the main pointto consider when you're
reviewing a borrower that has aC corp, ask them if they own a
hundred percent of the stock.

(05:06):
If they do not own a hundredpercent of the stock, then, um,
you should be good.
Now, how would you, uh, showtheir ownership?
Well, it may be a little toughbecause it's not always possible
to obtain the corporate taxreturn, the 1120 S.

(05:26):
Maybe they would be willing to,uh, to show the 1125 E.
Which is the compensation ofofficers schedule in the 1120s.
That's the one that states, youknow, how much is their
percentage of ownership and whatis the distribution that is

(05:49):
being given to that borrower.
Now, um, please note thattypically, uh, if it is, uh, a
self employed borrower now, ifit's been determined that they
do own a hundred percent of thestock, so they would actually be
considered self employed.
I mean, unless you're submittingyour file to that one investor,

(06:12):
that is an exception at 25%.
But assuming you do have 100percent and borrow that onto 100
percent of the stock, then, uh,for them to be considered self
employed, you would typicallyneed a two year history, right?
This is going to be the same as,uh, any other scenario.
A couple of exceptions, borrowerreceiving same or greater

(06:32):
income.
Thank you.
In a similar field or positionor borrower in a similar
occupation in which they hadsimilar responsibilities.
Now, this may be a little bittougher when you're dealing with
a C Corp, as opposed to whenyou're dealing with a sole
proprietor or dealing with an SCorp.
But those would be the only wayto grant exceptions to the two

(06:56):
year rule.
Now, as far as the incomestream, right, how do we track
it?
So the income and expenses, inother words, a profit and loss
of the true corporation isreported on, on IRS form 1120,

(07:19):
which is the corporate taxreturn.
Uh, please note that do notconfuse this with the 1120 S as
in Sam, which is the Scorporation tax return.
So for the C corporation, thetrue corporation, it is simply
form 1120 S.

(07:41):
So that's where all the profitand loss is reported.
And then the distributions are1125 E.
And that is if the grossreceipts of the company exceed
500, 000.
At that point then, thosedistributions are dividends on

(08:05):
the 1040 Schedule B.
That's the, the 1040 is apersonal tax return of the
borrower, Schedule B.
That's where the dividends arereported.
So please note that dividendsaren't always You know, from
stocks, from an investment inthe quote unquote, the stock
market, but it could be actuallywhere you have a substantial

(08:25):
investment in a corporation, uh,to the point that, uh, you know,
you're, you, you, you're namedon the 1125 E and getting a
substantial portion of dividendsvia distribution.
Now, there's two ways that theborrower is going to get income

(08:46):
from that corporation.
Okay.
Um, one way is through, uh,dividend distribution and the
other one is through actual W 2wages.
Uh, and now please note thatthey're considered W 2 wages for
an employee if they do, if theyown less than 100 percent of the
stock of the corporation.

(09:08):
And they're considered adistribution if the borrower is
100 percent owner of the stock.
Now here we're talking about theW 2 wages.
We're not talking about, uh,dividends.
District distribution, butactual W two wages, which is
just another way to get themoney into the borrower's hands.

(09:28):
And then also please note thatanother income document that you
that you will need if actuallyusing the Income from or losses
from the 1120 Is going to be theyear to date profit and loss
report whenever We are beyondthe first quarter of the year

(09:51):
You So after March 31st, that'swhen the first quarter ends, you
are going to be required toprovide.
And this again is assuming thatthe 1120 is required, right?
Because our borrower is ahundred percent owner of the
stock.
So if, uh, it's after March,March 31st, you're also going to

(10:11):
need a year to date profit andloss report.
So if the application, forexample, is in, um, May 15th.
We'll probably ask for a year todate profit and loss through the
end of April, right?
So you would have the year todate profit and loss report.
You'd have, I guess, uh, the, ifthis was 2025, right?

(10:32):
Or let's say it's 2024 right nowand the application is now
November, you're definitelygoing to need the year to date
profit and loss report, uh,through October 31st.
Uh, 2024 and then you would alsoneed the 2023 tax returns and
depending on your findings, ifthis is an automated
underwriting loan and they tellyou two years, then you would

(10:56):
need 2022 tax returns.
As well as 2023 in the year todate profit and loss for 2024.
If a U S says you only need oneyear, then you only need one
year.
And again, very importantly,this is assuming that, um, we,
that the borrower is a hundredpercent owner of the stock and
we are considering them selfemployed and we are asking them

(11:19):
then for the 1120.
Uh, that, uh, for thecorporation as well as their
1040 a year to date profit andloss.
And if they receive any W 2wages, obviously we'd need the W
2s, pay stubs, uh, just toconfirm, uh, that type of
income.
But again, if they're 100percent owner, that's going to

(11:41):
be a distribution and it's goingto, that W2 wages will be
included in the self employedborrower income calculation.
So that's either going to be theform 1084, which is the Fannie
Mae form or the form 91, whichis a Freddie Mac form.
Now I will state that a FreddieMac is a little bit more geared

(12:05):
towards self employed borrowers.
Uh, we all know how if thebusiness has been in existence
for at least five years, FreddieMac automatically gives you the
one year tax return findingsversus Fannie Mae is only going
to give you that findings ifthere's low risk in the deal.
Um, but one thing you definitelywant to note on any of these

(12:29):
businesses is, does the businesshave liquidity?
Right.
That's the key.
Because if there are W 2earnings and stuff being paid to
the borrower and if there aredistributions, we want to make
sure that, that the business hasliquidity to continue to pay.
So you would run a liquiditytest or our liquidity
calculators, but you know,liquidity is basically assets

(12:51):
minus liabilities.
One of the biggest categoriesthat's going to come into
question here.
Are mortgages held for more thana year or mortgages held for
less than a year?
That's another component in theliabilities, because if it's a
line of credit that continuallyrenews, we may be able to

(13:14):
exclude it, uh, since it is nota long term loan, right?
So, but you know, um, thebusiness has liquidity.
If assets are greater thanliabilities, but before I go on
into the next and final slide, Iwant to remind everybody the key

(13:36):
takeaway from this page andprobably the key takeaway from
this whole presentation is thata C corporation, uh, borrower
has to own 100 percent of thestock of the corporation in
order to be considered selfemployed.
And they have to own 100 percentof the stock of the corporation

(13:56):
in order to be able to use theincome or have losses considered
against their income.
That's the most importanttakeaway from this whole
presentation today, becausethat's the argument I've used
many times when they've, whenthey get, um, you know, start
asking questions on that 1120tax return.
And as long as you can provethat the borrower is not 100

(14:19):
percent owner of the stock, youcan usually, you know, Stop them
cold in their tracks.
So this is similar to the keyconcepts on the items that can
be added back or have to becounted against the borrower.
This is the same on an S corp aswell as a sole proprietor,

(14:43):
right?
So we have non cash expenses,which are expenses that are
added back to income.
So when you're completing yourincome calculator.
Very important to note theseitems.
The income calculator will tellyou where to find these on the
1120, on the 1120s, as well ason the Schedule C.

(15:03):
So non cash expenses would beitems such as depreciation,
depletion, Or amortization.
And I'll be clear.
Amortization does not meanpaying down a mortgage in this
scenario.
Amortization is one timebusiness startup expense, right?

(15:25):
Uh, surveys, um, all, all thework that had to be done.
Setting up the business, payingaccountants, getting patents,
copyrights, whatever, uh, it maybe the expenses to start up the
business because that's whatamortization is.
One time business startupexpenses, depletion, exhaustion

(15:46):
of natural resources.
We all know what depreciationis.
It can either be on real estateor on personal property.
Another key concept here isexpenses is limited by the IRS.
So, uh, the IRS, uh, andspecifically the most common one
in this category are meals.

(16:07):
Now, what do they mean byexpensive limited to the IRS?
Well, meals, the IRS only letsyou deduct 50 percent of the
meal, which means, uh, There'sanother 50 percent floating
around out there.
That's an actual expense.
In the income calculations,you're asked to add that expense

(16:27):
back, which will be deductedfrom the income, right?
So the 50 percent that wasn'tdeducted, um, as a, as an
expense will be added as anexpense.
So if it's 5, 000, then it's 5,000 to, uh, reduction to the
income in the income calculator.

(16:50):
And, uh, last category we havehere is recurring versus non
recurring income or loss.
This is a very importantcategory here because,
especially on the non recurringloss part.
The non recurring income, ifit's non recurring income, we
know we can't use it, but it'salways good to reach out, have

(17:12):
the borrower reach out to theaccountant and we can reach out
to the accountant and find outwhat type of income was that non
recurring income, just to ensureif we can or cannot use it.
But what we're really going tofocus more on in this category
is on the non recurring loss.
That's the one that's affectingyou as well because it's on

(17:34):
there.
But the fact of the matter isthat is a paper loss, right?
The, the, the recurring lossesor recurring income when it's
recurring is expected tocontinue for at least the next
three years.
Right?
So we've got that three yearrule there.
And versus non recurring, whichis a one time event that cannot

(17:56):
be considered towards income orexpenses.
Now, what would be somecategories on this?
Well, we have, for example, thesale of an asset, like a vehicle
or equipment, where the businessis not in that type of business.
We have a casualty loss, Right.
Which is like an insuranceclaim.

(18:17):
You had to pay deductible of 5,000 out of pocket, or maybe
insurance didn't cover, or maybeit was theft and it was under
the deductible.
Whatever is the out of pocketloss on a casualty loss can be
written off.
Or a, or a paper loss that iscarried forward, right?
That tends to be the more commonones where five years ago, they

(18:39):
had a big loss.
And due to some IRS rule, theyallow you to spread out the loss
over a certain number of years.
So as long as we getdocumentation from the
accountant as to what is thenature of this loss, then, uh,
we may be able to get that lossexcluded, right, which will

(19:00):
improve our income and hopefullyour DTI.
So this is, uh, very importantand this is where you would be
working with the, uh, borrowerand with their accountant for
any type of these explanationson the recurring versus non
recurring losses.
It's several times I've beenable to reach out to an
accountant, uh, on a, uh, onetime loss on a non recurring

(19:23):
loss and have been able to getit waived, uh, and have been
able to close the loan based onthat.
Without that, we were over.
With that, we are under.
So, um, that completes ourslides and I wanted to see, I
don't see anyone with anyquestion.
Okay, I do have a question here.
Uh, is an LLC considered a CCorporation?

(19:49):
An LLC is just another, uh,entity, but it is not,
definitely not considered a CCorporation.
I'll have an LLC on next week'straining so you could compare.
Okay.
But the the C Corp is the onethat where the borrower is most
removed from ownership and theliability of ownership as the

(20:13):
name implies, right?
It's a legal entity existingseparately from its
shareholders.
All right, so I'm not seeing anyadditional questions here.
I'll give it a minute, uh,because remember, I mean, C
Corp, S Corp, sole proprietor.
Those are the three entitiesthat we've covered so far.

(20:35):
They're all a little bitdifferent and very important to
know.
Well, no additional questions.
So it looks like we are done fortoday.
I do appreciate you all checkingout today's training and look
forward to seeing you nextTuesday.
Have a good, have a good rest ofyour day.

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Loan Officer Training - 11/14/2024 - Analyzing Self-Employed Borrower Income: C-Corporations

Episode Transcript

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