It’s hard to believe that it is almost time to start thinking about gathering all of the receipts and supportive information required to complete Federal tax returns again. If there is a housing decision in your immediate future make sure you carefully plan in advance of preparation.
Income is a major factor when a mortgage company qualifies you to purchase a home. First, I want to make it very clear that the IRS states that any income received in a calendar year is to be reported. However, anyone reading this knows that there is a lot of money that exchanges hands that never gets properly reported. The importance in this discussion, is that if you don’t report the income, do not expect to be able to include it as qualifying income. Understand the “two edged sword” consequence of your decision.
Self-employed buyers that are sole proprietors typically complete a Schedule C that reflects revenues and expenses. In an attempt to reduce taxable income, it is not unusual that many self-employed individuals write off as much expense as possible. Revenues of $50,000, become net income of $15,000. The mortgage company will only be able to use the net income of $15,000 in this example and only be able to add back depreciation expense if there is any. It is with frequency that a self-employed client will tell me that he made $50,000 in the above example.
If you are self-employed, learn to understand the difference between revenue and income and plan appropriately. You are going to pay more to the IRS but will be in a better position to buy a home if you are careful about reducing revenue too much!
Self-employed buyers are not the only ones that need to give careful consideration to what income they intend to report to the IRS. If you are in a profession that involves significant tip income, how much you declare is something for you to give careful consideration to. Waiters, bartenders, and beauticians receive regular tip income. If you want it to be considered as income, this becomes part of a two year plan as a two year average of this income is calculated for qualifying purposes.
If you itemize and complete a Schedule A, understand that unreimbursed business expenses can reduce your taxable and qualifying income. If the total of unreimbursed business expenses exceed 2% of your adjusted gross income, the amount in excess of 2% reduces taxable income with certain limitations depending on the amount of your income. Sales professionals frequently complete a Schedule 2106 (unreimbursed expenses). If you reduce your income watch out for the “two edged sword” effect.
One of my biggest pet peeves, is the individual that provides the tax preparer with a list, or a box of receipts of unreimbursed expenses that DO NOT EXCEED 2% of adjusted income. Most preparers reflect the total anyway on the Schedule A without understanding that the amount that is reflected, providing you no tax relief, has just reduced your income for mortgage qualifying purposes! Let’s make this clearer. If you earn $70,000 annually (let’s assume that amount is also your line 38 adjusted gross) and your unreimbursed expenses total $1,375.00, you receive no deduction. HOWEVER, your friendly mortgage underwriter is going to reduce your annual income that year by $1,375.00. Sound innocent? Not enough to make a difference? There are many cases where an additional $114.58 monthly might affect an investor’s decision. Make sure you tell your tax preparer, if there is no benefit from the calculation, remove it from the Schedule A.
This just scratches the surface of planning for tax preparation. If any of this is confusing, e-mail me at hgordon@monarchmtg.com.
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