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In the Introduction, we listed the various types of business you may see when underwriting and documenting a self-employed borrower. In this learning clip, the business type we will focus on is the corporation.
Please remember that you are responsible for determining if your borrower’s income documentation demonstrates that he or she will have the financial ability to repay the mortgage.
The following chart describes the tax reporting information and advantages/disadvantages of a U.S. corporation.
Number of Owners |
No limit on number of shareholders |
Where is business income reported? |
Form 1120 |
Where is owners' income reported? |
Wages line of Form 1040 or borrower's W-2 |
Taxation of business income |
-Corporate income is taxed at corporate rate. If this income is paid to shareholders as dividends, the shareholders pay tax on it at personal rate. |
Main Advantage |
- Shareholders are not personally liable for the corporation's debt. |
Main Disadvantage |
Double taxation issue: corporate income is taxed at corporate rate. If income is paid to shareholders as dividends, this income is again taxed at their personal rate. |
 Bill's inventory |
Bill owns a very profitable Italian/Jewish deli in Sarasota, Florida. His gross receipts, or sales, totaled almost a million and a half dollars for 2005—a very nice business. For this study, assume the documentation level returned by Loan Prospector is Streamlined Accept. |
Bill's tax returns in a U.S. Corporation are provided for further clarification.
Here you see Form 1120 for Bill’s Deli. This form mirrors Form 1120S used for S Corporation income reporting.
Schedule E on page 2 of Form 1120 is where you need to look to determine the borrower’s percent of stock ownership and amount of compensation. You can also find this information in the "Article of Incorporation" for each U.S. state. [To play movie, click right blue arrow below]
Schedule K shows the accounting method. Freddie Mac accepts all accounting methods as long as they are used consistently.
Schedule L below is the balance sheet. Line 15 shows year-end assets of over $4.8 million, but they are not all liquid. Liabilities include a loan from shareholder Bob (line 19). With cash assets of just $287,900, what happens if Bob demands his loan of $300,000 be paid back immediately? Along with the cash, Bill's Deli can use retained earnings (line 24) of over $750,000 to repay Bob.
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