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If the borrower has less than 25% business ownership, and receives a Schedule K-1, can the income be used to qualify?

Schedule K-1 Income 

The following table provides verification of income requirements for borrowers who have less than 25% ownership of a partnership, S corporation, or limited liability company (LLC). For borrowers who have more than 25% ownership, lenders must follow the verification of income requirements for self-employed borrowers. See B3-3.2-01, Underwriting Factors and Documentation for a Self-Employed Borrower for additional information.

Verification of Schedule K-1 Income
 

The borrower must provide the most recent two years of

  • signed individual federal income tax returns, and
  • IRS Schedule K-1.
 

Income reported on Schedule K-1 can only be considered if the lender obtains documentation verifying that

  • the income was actually distributed to the borrower and is consistent with the level of business income being used to qualify, or
  • the business has adequate liquidity to support the withdrawal of earnings. The lender may use discretion in the method used to confirm the business has adequate liquidity.
  The lender is not required to analyze the viability of the business in accordance with self-employment requirements and may only use the borrower's proportionate share of earnings reflected on Schedule K-1 when calculating the borrower's income.
  If the borrower has a two-year history of receiving “guaranteed payments to the partner” from a partnership or an LLC, these payments can be added to the borrower’s cash flow.

Note: An exception to the two-year requirement of receiving “guaranteed payments to the partner” is if a borrower has recently acquired nominal ownership in a professional services partnership (for example, a medical practice or a law firm) after having an established employment history with the partnership. In this situation, the lender may rely on the borrower’s guaranteed compensation. This must be evidenced by the borrower’s partnership agreement and further supported by evidence of current year-to-date income.

For additional information, see FAQs: Analyzing Self-Employment Income and B3-3.1-09, Other Sources of Income.

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