Loan Officer Training - 12/03/2024 - Analyzing Self-employed Borrower Income: LLC

Understanding how to analyze self-employed borrower income is a key skill for every loan officer, especially when it comes to LLCs. In this episode of Loan Officer Training, we dive into the specifics of evaluating income for borrowers operating under a Limited Liability Company structure.

Join us as we unpack essential documents, explore common challenges, and share proven strategies to confidently assess eligibility. Whether you’re a seasoned professional or just starting out, this episode will equip you with the tools to navigate the complexities of LLC borrower income and help you close more deals.

Stay tuned for practical tips, expert insights, and real-world examples to sharpen your skills and take your loan officer expertise to the next level!

Join The Mortgage Calculator at https://themortgagecalculator.com/join

About The Mortgage Calculator:

The Mortgage Calculator is a licensed Mortgage Lender (NMLS #2377459) that specializes in using technology to enable borrowers to access Conventional, FHA, VA, and USDA Programs, as well as over 5,000 Non-QM mortgage loan programs using alternative income documentation! 

Using The Mortgage Calculator proprietary technology, borrowers can instantly price and quote thousands of mortgage loan programs in just a few clicks. The Mortgage Calculator technology also enables borrowers to instantly complete a full loan application and upload documents to our AI powered software to get qualified in just minutes!

Our team of over 350 licensed Mortgage Loan Originators can assist our customers with Conventional, FHA, VA and USDA mortgages as well as access thousands of mortgage programs using Alternative Income Documentation such as Bank Statement Mortgages, P&L Mortgages, Asset Based Mortgage Programs, No Ratio CDFI Loan Programs, DSCR Investor Mortgages, Commercial Mortgages, Fix and Flip Mortgages and thousands more!

Our Mortga

Catch all the episodes of the Loan Officer Training Podcast at https://themortgagecalculator.com/Page/Loan-Officer-Training-Series-Podcast

Catch all the episodes of the Loan Officer Training Podcast at https://themortgagecalculator.com/Page/Loan-Officer-Training-Series-Podcast

Loan Officers for Unlimited Free Non-QM Leads & Trainings Join The Mortgage Calculator at https://themortgagecalculator.com/join

The Mortgage Calculator is a licensed Mortgage Lender (NMLS #2377459) that specializes in using technology to enable borrowers to access Conventional, FHA, VA, and USDA Programs, as well as thousands of Non-QM mortgage loan program variations using alternative income documentation!

Using The Mortgage Calculator proprietary technology, borrowers can instantly price and quote thousands of mortgage loan programs in just a few clicks. The Mortgage Calculator technology also enables borrowers to instantly complete a full loan application and upload documents to our AI powered software to get qualified in just minutes!

Our team of licensed Mortgage Loan Originators can assist our customers with Conventional, FHA, VA and USDA mortgages as well as acc...

Transcript

Restream recording Dec 03, 2024 • 05:01:14 PM: 0:13

So what exactly is a limited liability company? LLC, right? That's what LLC stands for. Now, this is very important to note because this is what you need to know. So, you know, what documentation to ask when analyzing the income, that's the main purpose of this training. We, we're not specifically breaking down, analyzing the numbers, but we are providing the structure so that, you know, we're not. What is the documentation that you need to look for, to review, to analyze so that your income analysis is correct? Because, um, one of the mistakes that we find, uh, uh, that MLOs, uh, do when they're calculating self employed borrower income is that they may not ask for the business tax returns or the partnership tax returns. They're simply going to use the personal tax returns. And if you do that, um, unfortunately the borrower could be Leaving a lot of money on the table, and that would be you leaving their money on the table because you would not be recapturing certain expenses, for example, that could be added back that would only be on the business or corporate tax return. None of that is going to be noted on the personal tax return, because the personal tax return is going to talk about a net amount. So an LLC, aka limited liability company, is a hybrid business structure that combines the limited liability of a corporation with the pass through taxation of a partnership or sole proprietorship. Um, most LLCs out there are operated. As partnerships, but we do have LLCs that actually file. Escort 1120s tax returns because they're an LLC, right? The, the entity, if you want to call it instead of the individual that owns the Escort is an LLC, and then they file the 1120s. And then, you know, I'll go through that income stream in a minute, uh, but that's how that, uh, scenario works. So the, uh, and hold on, let me, uh, do something a minute here so that I can, uh, correct everybody's view a second. Give me a minute here. Sorry. Give me one second. I'm going to better your view because I actually have this part. On another slide, so everyone can better see what we're doing here. All right, now I think you guys see a little bit better what's going on. I got that part that I deleted actually on the slide on page 3. So, The uh, okay, so let's get back to business. The LLC is a hybrid business structure. Okay, I mentioned this already that combines the limited liability of a corporation with pass through taxation of a partnership or sole proprietorship. So I already mentioned it could be being operated as a partnership or it could be being operated as an escort. Uh, LLCs are operated according to an operating agreement, right? The operating agreement, that's basically their rules and regulations. LLC owners called members, right, the members of an LLC are the owners, are not usually personally liable. For the debts and obligations of the business, right? So that's similar to a corporation as opposed to a partnership where in a partnership, the business owners are 100 percent liable for the expenses and obligations of the business. Uh, and now an O. C. has the benefit of being a pass through entity. This is benefit, but it's also a negative where taxes are paid by the partners personally through their 10 40 tax return, right? As opposed to, um, if it's a C corp, right, but an S corp. Is also a pass through entity where taxes are paid by the partners personally through their 1040. What's limited is the liability of the expenses and obligations other than taxes. Now, um, I always like to cover this part of what exactly is meant by self employed. Um, when we're analyzing borrowers, now this is applicable for an LLC. This is applicable for an S Corp partnership, sole proprietorship. This is not applicable for a C Corp, right? A C Corp is an actual entity that exists on its own, but for all of the, uh, business structures, other than a C Corp, an individual is considered self employed. When they have a 25 percent or greater ownership interest in a business. So 24. 9%, they're not, uh, self employed 25. 0 percent and greater. They are considered self employed. Now, usually we need a two year history of self employment. to be able to use the self employment income. But as is usually the case, there are exceptions to this two year rule. The exceptions are if the borrower is receiving the same or greater income in a similar field or position, or if the borrower is in a similar occupation In which they had similar responsibilities number to the second one. There's a second bullet point is the one that we normally use in the exception. This bullet point would be applicable. For example, a doctor. Right? We have loans where the and I had to come recently through my desk. in review for another MLO, where the doctor was previously a W 2 employee, right? Then they transitioned to 1099 employee, they formed their LLC, and now they're self employed, right? But they're still a doctor, they're still doing the same occupation that they had when they were W 2 employee. So we would probably be able to use that income as long as we have at least 12 months worth of income for that income stream. Now, if you're going non QM, you know, again, you gotta review the guidelines. There's a little bit more, uh, flexibility in the non QM world, especially If you're choosing the 1099 program instead of a full doc program, for example, uh, the, the doctor that we had had only had, um, I think nine months of 1099 income, but they had plenty of W 2 income and it was a really solid continuous stream. So we were able to get that one closed, but no two year history is required. Unless your borrower, um, falls into one of these categories. Another one would be, um, electrician who has a license. For example, maybe they were working as a W2 employee. They still had to have their license to be an electrician. And now they transition, they have their own business, same license, you know, but now they're just doing it on their own. We would probably be able to close that one. Uh, As a self employed borrower, as long as we met the minimum number of months, uh, sometimes it lasts for 12 months, like I mentioned, of, uh, self employment just so that they can properly calculate 12 months worth of income. So, we're talking about income, so, uh, it's really important to note that the reporting of the income, will depend on the business structure of the LLC due to the hybrid nature of an LLC. I mentioned the LLC could operate as a partnership or it could operate as, for example, as an S corporation. Which are the two most popular? In common structures for an LLC. The most common one will probably be a partnership. And second will be an S Corp. What does that mean for you? Now this is the part where you gotta really open your eyes and pay attention. Because this is what's gonna determine if you calculate your income correctly or not. Right. Um, because it's now in some cases, uh, if it's a single member LLC, and they may not, they will not have a 1065 report, which is the partnership tax return, and they may or may not have an S corp, in which case that single member LLC is probably just going to report their income on the schedule seat of the tax return. And then that will go to Schedule 1, and then that will go to the front page of the 1040 in Line 8, where they report the self employed income that comes over from Schedule 1. Uh, that's also a lot less common. Mostly, you're going to have the first option, which is a partnership. So when you are interviewing your borrower, And you see that they are self employed. You're going to ask them, uh, do you have an LLC formed? Or are you just, uh, you know, you hopefully you'll see you'll have their 1040. And if you see a schedule C there and you see that's where the reporting income, you're still going to want to ask them. And you're going to look for schedule E to see on page two, if there's any entries, because if they do have a partnership on, you know, you're going to look at the 1040 tax return and you're going to look for schedule E. Of the 1040 tax return and specifically, you're going to look for page 2 of the schedule E. If there is a page 2, because normally the schedule E has rental real estate income, right? That would be on page 1, but if they have any royalties that they're receiving or income that they're receiving from a partnership or corporation, 2. To the Schedule E. If you see a page 2, there's an entry there with an entity's tax ID number, for example, then you got to investigate further and you got to see, is that an S Corp? Is that a C Corp? Is that a partnership? What exactly is it? That's reporting that income in page two. And then you're going to have to ask the borrower if they did not provide that document to provide it. So if it's determined, if, if from your, uh, investigation, there is determined that it's a partnership, then do know that partnership income is reported on IRS form 1065, that is the partnership tax return, and then each partners share Is reported on a schedule 1. So if they're 5050 owner, there'll be 2 K1s issued to each partner is going to say that they're 50 percent owner and it's going to have the income that was distributed to that partnership on the schedule K1 and then that income from the schedule K1. Is then reported on the personal tax return, the 1040 of the borrower via Schedule E, page 2. And then, uh, that income reported on Schedule E, page 2, is reported on the 1040, Schedule 1. And then finally, the income reported on Schedule 1 is reported on page 1 of the 1040, line 8. So that's, that's the, uh, the path that the money takes. To get to the borrower if they have a partnership. And if there is an S corp, then the, um, the income. Um, if you, if it's determined that it is an S corp, then you're gonna request the S corp 1120 s tax return. That's where an S corp files their taxes. Again, each partner share is reported on the K one. And then that follows the same path. It goes to then that K 1 income is reported on the 1040 Schedule E. Page 2, and then it gets reported on the 1040 Schedule 1, and then also goes to line 8 on page 1 of the 1040, which is the self employed borrower income. So if you see anything on page 1, on page 1, line 8, Of the 10, of the 1040 tax return, there's some, some type of self employment income going on. There's an additional income stream that's not W 2 income. So this page here, very important, uh, to you making sure that you have the correct documentation to review the income and are not just looking at the 1040. And then last but not least, I do include this page here because this is a very important page, right? These are the expenses that may be added back, uh, or maybe, um, not considered, right? So what are we talking about? Well, we're talking about non cash expenses. Uh, uh, for example, non cash expenses. Now, there's three categories here. Non cash expenses, expenses limited by the IRS, and recurring and non recurring income or loss. Now this is very important that you review these. Because these do give you options to some, like I was saying, in some cases, recapture income. So non cash expenses can be added back to income. The most common example of non cash expenses that can be added back to income are depreciation on real estate. Or on personal property, uh, business property, should I state like a car equipment, furniture, that would be the channel asset depletion is another non cash expense, which would be exhaustion of a natural resource. And it specifically has to say, you know, there is a category specifically for depletion. When you're reviewing the partnership return or the S corp return, there's going to be a category for depreciation. Category for depreciation, uh, depletion. And then you also have amortization. Amortization is a one time business startup expense, and it specifically has to say amortization. Now, I think you may be able to get away with including it. If it says business startup expense and the, um, accountant didn't specifically notated as amortization, but they put business startup expense and they put an amount. You could most likely I think an underwriter will agree with you on that one. In that case, it's just a matter of semantics, right? Another category here, uh, this is not a good one, right? These are expenses limited by the IRS. This category Is reduced from the income and the reason it's reduced from the income is due to the fact that it is an expense that is limited. In other words, the IRS does not let you deduct 100 percent of the expense. You're only deducting 50 percent of it. For example, in the case of meals, which is the most common expense. In the case of meals, uh, the IRS only lets you deduct 50 percent of the amount. So the other 50 percent that is not deducted, guess, guess what happens with that? It's deducted from the income. So it reduces the income. So if you have 3, 500 in meals included there, guess what happens there? That goes in, in your income calculation worksheet in the minus column, uh, for expenses that are deducted. And that's going to be deducted from the income that they reported. And the third category here, and these are not in order of importance, these are all equally important, are the recurring versus non recurring income or loss. So a recurring item is an item that's expected to continue for at least the next three years. Right. So if we have an item, now what usually happens here is that we have items listed in the non recurring column, like a non, a non recurring loss or a non recurring income, that is a one time event that cannot be considered towards income nor expenses. Uh, examples of this would be the sale of an asset, like let's say a piece of equipment, expensive equipment. Originally costs, let's say a million dollars. Now they're selling it for a hundred thousand dollars because they're buying a new, the latest and greatest version of that equipment. So now you see in the other income column, I don't know, maybe like two or three of the, uh, of the, uh, return. And it's going to have a hundred thousand dollars, but guess what? You cannot use that income unless you can document that it was not a non recurring income. income that would entail reaching out to the accountant and finding out if that's what was the nature of that income. And is that something we can use? Because if it is a non recurring one time event, then you have to deduct it from the income, right? You have to make sure because I want to tell you the underwriter is going to deduct it from the income. So do not overstate your income because you missed that one there. Which is a non recurring income. Now, where we really like to use this, uh, this, uh, category of non recurring is in the losses, right? You get an, a non recurring loss that you can add back. So you could have, for example, a business four years ago, I had a million dollar loss and through some IRS tax code, they allow them. To write off 50, 000 a year for the next 20 years of that loss for whatever, for whatever reason. Right? I mean, we're not an accountant, but we can certainly reach out or have the bar reach out to the accountant to provide a letter of explanation as what was that loss. So that we can document to underwriting that that is a non recurring, also known as a paper loss, that was carried forward. Or it could have been a casualty loss, right? Casualty losses are another non recurring loss that you can add back, right? That's a one time loss. They had a 100, 000 loss. They had a 15, 000 deductible. That's an expense. That's a one time loss. You can probably add that back because that's not going to occur every year. And likewise, if they got that paper loss that they're carrying forward for the next 20 years, you can add that back. The important thing is to have a letter of documentation, preferably from the tax preparer. Documenting what it is and possibly providing additional documentation to support the letter that they're providing if it's sort of a convoluted situation, right? Which I just mentioned on the last bullet point, which is so important, right? The expense needs to be documented as a one time expense via letter from the accountant if a paper loss or supporting documentation if a casualty. loss. So are there any questions? This is your opportunity to ask your questions. I know that you guys have questions when you come seek out assistance. So do you have any questions on income, on self employed bar income? It could be on the items that I presented here, or it could be on any facet. Of self employed borrower income and yes, we do provide copies of the presentations. Well, I'm going to give it another minute here because I don't see any questions. I know. I probably did a great thorough job on this. But, uh, yeah, I already answered that we can, uh, we. Upload these, uh, PowerPoints. To our database. So, no questions on the subject matter. So, um, I will look forward to seeing everybody tomorrow for tomorrow's training episode. Have a great day.