|Business ownership may change mortgage status
When applying for a home, mortgage companies will classify you as a wage earner employee or self-employed.
How you file your taxes in accordance with your percentage of business ownership could classify you as self-employed even though you are an employee.
The following are some things you’ll need to know to meet the ability to repay requirements.
Lending income buckets
• Bucket 1, employee: Individuals receive an annual W2 of their earnings and received paychecks throughout the year. From the paycheck, federal state and taxes are withheld.
• Bucket 2, self-employed: This includes a sole proprietorship, any business entity where income is derived or lost including all affiliated corporations, income derived from real estate, and/or dividend income is also considered to be under the self-employed bucket.
Where things may overlap
Employees who also have an ownership interest in the company can actually be considered self-employed.
Yep, it’s true.
For example, if you’re a W2 wage earner employee and you have an ownership interest in your company whom you’re employed for that is more than 25 percent, you are self-employed for the purposes of applying for the loan. Additionally, if you own the company but receive a W2, you are still considered self-employed even though you receive a W2 because you control the salary you take.
How another business
affects mortgage application
Your federal tax returns are required for the lender in documenting your ability to repay. On your tax returns, as a sole proprietor, a Schedule C is filed, and the income will carry a Schedule A. However, things change when you have a business.
Two factors enter the picture. The first, schedule E identifies whether or not there is additional business income and/or that you are an owner in an additional business.
Second, if additional businesses are identified, the housing lender will require the K-1 for each business to determine the amount of percentage of ownership.
• Mortgage Tip: if you own 24 percent of a business, you are not self-employed for the purposes of the loan application, and the lender will not need to obtain the corporate income tax returns.
On the flipside, if you own 25 percent or more of an additional business, whether it’s your current employer or another business entity, as identified on the K-1, then you’ll need to provide additional income tax returns for the Corporation in addition to your personal tax returns for obtaining the mortgage.
Why all the questions?
Providing W2s, pay stubs and personal tax returns is not enough if you have more than a 25-percent business ownership percentage elsewhere.
If you’re receiving additional income from another business and income or loss of income is tied to your personal tax returns, it becomes material to your ability to qualify.
Here’s why: lenders are required to average your income over the last two years and that averaged income is used on the loan application in procuring new financing.
See how much you can afford with our income affordability calculator.
So, if you’re self-employed simply by virtue of having an ownership interest in a company, you need not provide the additional tax returns if you are a small share owner.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.