Why the renewed interest in how partnership and S Corp income is calculated and used for qualifying income? Over the past year, Fannie Mae made a clarification for determining qualifying income from Partnership and S Corp K-1s. Nothing is really new — but it’s making us rethink what we thought we already knew. We need to do the same thing we’ve always done with self-employment income: Verify the stability, history and profitability of the business to support the likelihood that the income will continue.
So, if a partnership or S Corp is profitable and earning income, why can’t you just use those earnings for qualifying monthly income?
While the partnership or S Corp may be very profitable and earning income, it may or may not distribute some or any of that income to the partners or shareholders. Therein lies the challenge: IF the business shows a history of making cash distributions to the borrower consistent with the earnings, THEN you can use the income. Sounds easy enough, right?
Here’s where it gets a bit more challenging.
Oftentimes, the business has a history of earning income and also distributing earnings. The distribution may be much less than or significantly more than the earnings. In some cases there may be no distribution at all. The question becomes, how do you verify this income in order to use it as qualifying income?
You’ll need to take it to the next level, verifying:
- The business has positive sales and earnings trends
- The business has adequate liquidity to support the withdrawal
- The borrower can document ownership and access to the income
Verifying these factors helps assure that income will be available and is likely to continue and, therefore, is a potentially acceptable source of qualifying income. Conversely, you would deduct from cash flow any loss resulting from your analysis, as it represents a drain on the borrower’s income.
Simple right? Not always.
Keep in mind, as you dive into business returns and start looking at their balance sheets and income statements, you’ll gain a complete understanding of the solvency of the business as well as how sales and earnings have been trending. With that knowledge in hand, you can be confident in your final income used in qualifying.
If you can’t remember how to look at financial statements, have never looked at business returns or just need a refresher, MGIC’s Self-Employed Borrower resource manual is at your rescue! It’ll guide you through the nuances of conducting an analysis of balance sheets, income statements and trend analyses. You can find MGIC’s Self-employed resource guide posted on MGIC.com/SEB.
I must caution you though: All the knowledge you gain by reading this manual may make you the office expert and go-to guru regarding self-employed borrowers.
IMPORTANT: Requirements may vary significantly on the use of income from these sources, so always check your investor guidelines.
Watch our no-cost webinar about SEB for Business on our Training calendar!