FHA Self Employed Guidelines
A borrower with a 25% or greater ownership interest in a business is
considered self-employed. Income from self-employment may be used to qualify providing it is
considered stable and continuing. Typically, FHA requires a 2-year history
(verified by a full 2 years of income tax returns) of self-employment to consider the income as stable.
- Signed & dated individual tax returns (with all schedules - including W-2
forms and 1099 forms) for the most recent 2 year period is required. The returns must be signed & dated by the
- Signed copies of business income tax returns for the most recent 2 years (with all schedules) is also required if the business is a
Corporation, an “S” Corporation, or a Partnership.
- A year to date Profit and Loss statement (P&L) and balance sheet,
which is completed and executed by the borrower.
Analysis Of Income:
- The earnings trend must be averaged over the previous 2 years. The tax return information will be analyzed along with the year to date
income information. Higher year to date income will not be used. The average of the past 2 years is the true picture of income and expenses
and must be used.
- The financial strength of the business and the economic forecast for the
type of business must be analyzed. Annual earnings that show stable or
increasing income are acceptable. Earnings
that are declining are to be considered unacceptable.
Tax Return Analysis:
Individual 1040 Return:
- Schedule C: The borrower’s business is a sole
proprietorship. The borrower’s personal and business liability are the same.
Depreciation and depletion may be back to Adjusted Gross Income. (Referred to as “AGI” for remainder of section). (NOTE: Any
W-2 wage income derived from someone other than the borrower must be
deducted from the Adjusted gross income on the 1040).
- Schedule E: Income derived from rents, royalties, partnerships, etc. will
be shown on this form. Depreciation may be added back into AGI.
- Schedule D: Capital Gain or loss: Generally, this is a one-time (nonrecurring)
transaction and should not be used in determining income. However, if the business constantly has a turnover of assets that result
in a gain or loss of income, any positive income may be used provided a review of 3 years of current tax returns shows the positive
income figure. If this is documented, the average income for the 3 years
may be used. (And any loss shown in the same way is averaged, and the average is to be deducted from
borrower’s income used to qualify.)
- Schedule B: Interest and Dividend Income: This income (whether it is
taxable or tax-exempt) may be added back to the adjusted gross income
only if it has been received for the past 2 years and can be expected to continue for at least 3 more years.
- Other Schedules: Depreciation shown on Schedule F may be added
back into AGI. IRA distributions, Pensions & Annuities and Social Security benefits may have the
non-taxable portion added to AGI as long as the benefit is documented to continue for at least 3 years.
Other adjustments to income such as keogh, IRA, health insurance
deductions, and alimony payments may be added back into AGI. Employee business expenses on Form 2106 are
to be deducted from the AGI.
Corporate Tax Returns (Form 1120):
Corporations are owned by their stockholders and any compensation to
owners is shown on both the corporation’s tax return and the owner’s individual return. If the
borrower’s percentage of ownership in the
corporation is not shown on the corporate return, this information must be obtained from the accountant for the corporation. The accountant
must also verify that the borrower has access to the funds.
First, the Adjusted Business Income for the corporation is determined
and then it is multiplied by the percentage of the Borrower’s ownership.
To analyze the corporate returns, the following adjustments must be made to the adjusted business income:
- Depreciation and Depletion: Add back to “after tax” income.
- Taxable income: This is the corporation’s net income before Federal Income Taxes are calculated/paid. The amount of the
tax must be deducted from the taxable income.
- Fiscal year versus calendar year: If the corporation operates on
their own fiscal year, which does not match the actual calendar year, the adjustment must be made to relate to correct
percentage of income used.
- Cash withdrawals: If the borrower withdraws cash from the company for personal use, the negative impact on the ability to
operate the business must be verified.
“S” Corporations: (IRS form 1120S):
This business passes on gains or losses in the company income to the
owners (stockholders) in proportion to their individual percentage ownership.
Income from the corporation to the owner (borrower) is reported on a W-
2 and the borrower pays taxes on his individual 1040 form. (Compensation to Officers from the 1120S is transferred to the
Borrower’s 1040 form).
Depreciation and Depletion may be added back to income - in the degree of percentage of ownership interest in the business.
Debts to be paid by the corporation within 1 year must be
considered. The borrower’s percentage of obligation must be calculated, and reduced from income.
If the borrower withdraws cash from the business, any negative effect
on the business must be analyzed. It must be determined that the business sufficient operating income (cash) to continue at a stable rate.
Partnerships: (IRS Form 1065):
A partnership is formed when 2 or more individuals form a business and
shares the profits, losses and responsibility of the company.
Each partner pays taxes on their proportionate share of net partnership income.
The Form 1065 must be analyzed to ascertain the viability of the business. The Borrower’s share of the income will be carried over the to
borrower’s 1040 on the Schedule E.
Depreciation and depletion may be added back to income - using the
Borrower’s percentage of ownership.
Obligations/debts due within 1 year must be deducted from the Borrower’s share of the business income.
Withdrawals of cash by the borrower must be verified to have no negative impact on the company’s future ability to operate.