B3-3.3-02, Income Reported on IRS Form 1040 (05/15/2012)

To get an accurate picture of the borrower’s cash flow, the lender will need to make certain adjustments to some of the income (or loss) that the borrower reported on IRS Form 1040 since it may not be recurring income. The lender also may need to further analyze the accompanying tax schedules or supplemental tax forms.

This section describes how the lender should treat various components of the income (or loss) that a self-employed borrower reported on IRS Form 1040 in its cash flow analysis.

Note: Eligibility criteria for accepting income from specific non-business sources is generally the same as that for salaried or commissioned borrowers (see B3-3.1-01, General Income InformationB3-3.1-01, General Income Information).

If an amount is shown for wages, salary, or tips for a self-employed borrower, it may mean:

• the borrower operates as a corporation and pays himself or herself a salary or

• the borrower’s spouse is employed and receives a salary (either from the borrower’s business or from another employer).

If the income relates to the borrower’s spouse who is employed by another company and the income will be used in qualifying for the mortgage, the spouse’s income must be verified directly with their employer since it may be more appropriate to use the spouse’s current earnings in underwriting the mortgage. Any income that is based on current earnings or that will not be used for qualifying purposes should be deducted from the borrower’s cash flow.

The taxable interest and dividend income that is reported on IRS Form 1040, Schedule B, may be counted as stable income only if it has been received for the past two years. However, the income cannot be counted if the borrower is using the interest-bearing or dividend-producing asset as the source of the down payment or closing costs.

Any taxable interest or dividend income that is not recurring must be deducted from the borrower’s cash flow.

Tax-exempt interest income may be counted as stable income only if it has been received for the past two years and is expected to continue. If so, this income can be added to the borrower’s cash flow.

Taxable state and local tax refunds, credits, or offsets of state and local income taxes should not be used as qualifying income since the income was accounted for in the previous year’s tax returns. Therefore, the borrower’s cash flow must be adjusted accordingly.

Alimony may be accepted as qualifying income if it meets the requirements described in B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income. Any reported alimony received that is determined to be nonrecurring must be deducted from the borrower’s total income reported on IRS Form 1040.

Income received from IRA distributions, pensions, annuities, and Social Security benefits may be accepted as qualifying income. See B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income, for specific requirements.

The nontaxable portion of such recurring income must be added to the borrower’s cash flow. The tax-exempt portion of income from these sources may be increased to reflect the tax savings, as described in B3-3.1-01, General Income InformationB3-3.1-01, General Income Information. If the income from these sources is determined to be nonrecurring, the income must be deducted from the borrower’s cash flow.

Unemployment compensation may be considered as acceptable qualifying income if it meets the requirements described in B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income. Any reported unemployment compensation that is determined to be nonrecurring must be deducted from the borrower’s cash flow.

If the borrower reported income from other sources, the lender must verify that the income is an eligible source for qualifying purposes per the requirements described in B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income, for the applicable income source. Income that is determined to be nonrecurring or ineligible for qualifying purposes must be deducted from the borrower’s cash flow. If the borrower reported any nonrecurring losses, the borrower’s cash flow should be increased by the amount of the losses.