02/10/2016
20
14
TAX YEAR
EVALUATING the
Self-Employed Borrower
and other sources of income
Analyzing Business Tax Returns
Partnerships, S Corporations and Corporations
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02/10/2016
Legal Disclaimer
The information presented in these training materials is for general information
only, and is based on guidelines and practices generally accepted within the
mortgage finance industry and is not intended to be all-inclusive. MGIC makes no
representations or warranties of any kind with respect to the accuracy,
completeness or suitability for any purpose of the information contained in this
training.
MGIC expressly disclaims any and all warranties, express or implied, including
without limitation warranties of merchantability and fitness for a particular
purpose regarding these materials and our training program. In no event will
MGIC be liable for any direct, indirect, incidental, punitive or consequential
damages of any kind with respect the training or materials provided.
All examples are hypothetical and are for illustrative purposes only. Our training
is not intended and should not be interpreted or relied upon as legal advice. We
encourage you to seek advice from a qualified professional.
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Objectives
 February
1st changes
 Review
cash flow analysis concepts and business
structures
 Convert
tax entries into cash flow:
− Review K-1s, Partnership, S Corporation and
Corporation returns
 Rental income analysis with Form 8825
 Complete
business cash flow using Borrower case study
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02/10/2016
Significant Updates
 Completion
of new Form 1084 only required for selfemployed income
 Use
& documentation of K-1 income
 Completion
of FNMA Form 1088 - Comparative Income
Analysis – when business returns are required
 Alternate, documented methodology acceptable
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New Form 1084
Individual 1040 section:
Analysis is limited to these
Self-Employed income sources
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New Form 1084
Partnership & S Corp
Use of K-1 Ordinary Income/Losses:
To use Ordinary Income you must
document access to income by:

History of distributions consistent
with ordinary income
Or

Other documentation
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Partnership/S-Corps K-1s
No history of distributions?

Is it by choice?
 Business is solvent
 Positive income trends

OR
Is it by default?
 Business Agreement prohibits
 Business is insolvent – can’t afford it
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Partnership/S-Corp K-1s
IF…
• K-1s reflect history of receiving cash distributions
consistent with ordinary income being used to qualify
THEN…
• K-1 ordinary income may be included in borrower’s
cash flow
STOP.
• Nothing else is required
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Partnership/S-Corp K-1s
With Distributions
K-1 documents:
 Stable history

Receiving distributions

Consistent with business
income
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02/10/2016
Partnership/S-Corp K-1s
IF…
• K-1s do not reflect history of receiving cash
distributions OR distributions consistent with level
of ordinary income
BUT…you can document borrower’s:
• Ownership share
• Access to income (not required if 100% owner)
• Business has adequate liquidity to support withdrawal
of earnings
THEN…
• K-1 income may be included in borrower’s cash flow
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02/10/2016
Partnership/S-Corp K-1s
Without Distributions
K-1 documents:
Consistent level of business
income
AND
Borrower can document:
1. Ownership share
2. Has access to income
3. Business has adequate
liquidity to support
withdrawal
#1
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Access to Income
#2
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Liquidity Ratios-
#3
Module 3 of MGIC’s SEB Manual
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Business Tax Returns – Trend Analysis
 Used
to evaluate the business’ income history
and trends:
 Is the business stable?
 Can it sustain paying the income to
borrower?
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Form 1088
Income Trending:
 FNMA Form 1088
 Alternate, documented
methodology
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Page 3-13 of MGIC’s SEB Manual
Business Tax Returns – Trend Analysis
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Analyzing Business Tax Returns
 Used
to evaluate the business’ income history
and trends:
 Is the business stable?
 Can it sustain paying the income to
borrower?
 One
year of taxes – no trending
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Analyzing Financial Statements
Business Entity

Is it stable, viable, solvent?

Profit & Loss Statements

Balance Sheets

Income Statements
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Objectives
 February
1st changes
 Review
cash flow analysis concepts and business
structures
 Convert
tax entries into cash flow:
− Review K-1s, Partnership, S Corporation and
Corporation returns
 Rental income analysis with Form 8825
 Complete
business cash flow using Borrower case
study
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Taxable Income vs. Cash Flow
Taxable Income
Cash Flow Income
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Non-cash Expense

Expenses deducted from cash flow that do not
require an actual cash payment

3 types of ‘Non-cash’ expenses
– Depreciation
– Depletion
– Amortization

Non-cash expense can be added back to cash flow
if included in total expenses

Form 2106, Schedule C, E, F & business returns
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IRS Limited Expenses

Meals and Entertainment
− Schedule
2106, C, and Business Returns
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Recurring
Income & Expense
Nonrecurring
Income & Expense
Income:
Expected to continue
3 or more years
Income:
One-time occurrence
(e.g., sale of an
asset, prize)
Expense:
Day-to-day cost of
business operations
Expense:
Extraordinary onetime occurrence
(e.g., casualty loss)
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Business Structures
Sole
Proprietorship
• Schedule C
• Note: In some
instances an LLC
may be filed with
Schedule C
Partnership
• Form 1065
e.g. General,
Limited & Limited
Liability
• K-1 (Form 1065),
e.g. General,
Limited & Limited
Liability Company
Corporation
• S Corporation –
Form 1120S
• K-1 (Form 1120S)
and/or W-2
• Corporation –
Form 1120 & W-2
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MGIC’s Form
Includes all fields on Form 1084
PLUS …
Assists in analysis of
“non self-employed income”:
-commissions/2106 expenses
-interest/dividend income
-alimony
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MGIC’s Form
Matches fields on Form 1084 ; use of K-1 Ordinary Income/Loss
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Cash Flow Analysis
AGI Method
Adjusted Gross Income
SAM Method
Schedule Analysis Method
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Cash Flow Analysis –
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Cash Flow Analysis –
AGI Method
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John and Ginny Borrower – 1003 Summary
Jointly
John
Ginny
• Married with no dependents
• Own three rental properties
• Sole proprietor of Up & Running computer
service
• 20% partner in Tanglewood Realty
• 50% owner of Creative Network Design
Services, an S Corporation; he does not take
an active part in management
• 50% owner of Westchester Development,
LLC
• 100% owner and manager of Interior
Innovations Incorporated, a regular
corporation
• Part-time sales rep for Creative Greeting
Cards
• 50% owner of Westchester Development,
LLC
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John and Ginny Borrower – 1003 Summary
Jointly
John
Ginny
• Married with no dependents
• 20% partner in Tanglewood Realty
• 50% owner of Creative Network Design
Services, an S Corporation; he does not take
an active part in management
• 50% owner of Westchester Development,
LLC
• 100% owner and manager of Interior
Innovations Incorporated, a regular
corporation
• 50% owner of Westchester Development,
LLC
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Case Study pg. 3
Form 1040
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Form 1040
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Case Study pg. 1 Manual pg. 1-3
Form W-2
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Case Study pg. 3 Manual pg. 1-5
Form 1040
Savings/CD’s
Stocks/mutual funds
Divorce decree
i.e., Seasonal work?
i.e., Consulting/contract
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Business Structures
Partnership
Corporation
• Form 1065
e.g., General, Limited & Limited
Liability
• S Corporation – Form 1120S
• K-1 (Form 1065), e.g., General,
Limited & Limited Liability
Company
• Corporation –
Form 1120 & W-2
• K-1 (Form 1120S) and/or W-2
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Flow of Partnership/S Corporation
Income or Loss
1065
Partnership Return
Partnership
S
Corporation
Line 22
__________
Income / Loss
1120S
S Corporation
Return
Line 21
__________
1065
Schedule K-1
Ownership % Lines
1 _________
2 _________
3 _________
1120S
Schedule K-1
Ownership % Lines
1040
Schedule E
Part II
1040
Line 17
___
1 _________
2 _________
3 _________
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Case Study pg. 14 Manual pg. 1-47
Schedule E – page 2
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Case Study pg. 16 Manual pg. 2-5
Schedule K-1 (Form 1065)
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Case Study pg. 16 Manual pg. 2-3
Schedule K-1 (Form 1065)
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Case Study pg. 16 Manual pg. 2-5
Schedule K-1 (Form 1065)
X
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Section IX, Partnership K-1 (Form 1065) - Tanglewood
Effect on Cash Flow Analysis
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Case Study pg. 18 & 19 Manual pg. 2-3 & 2-5
Schedule K-1 (Form 1065)
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Section IX, Partnership K-1 (Form 1065) - Westchester
Effect on Cash Flow Analysis
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Section X, Form 1065 & Section IX, Partnership K-1 (Form 1065) - Westchester
Effect on Cash Flow Analysis
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3
0
0
0
0
0
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Case Study pg. 27-31 Manual pg. 2-9 to 2-15
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Case Study pg. 32 Manual pg. 2-7
If John & Ginny are
personally liable for
debt…
But Partnership
owns the property
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Case Study pg. 32 Manual pg. 2-7
If John & Ginny are personally
liable for debt…but Partnership
owns the property
X
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Rental Income Worksheet
That’s it… stop.
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Case Study pg. 20 Manual pg. 2-17
Schedule K-1
(Form 1120S)
Shareholder’s
percentage of
stock ownership
for tax year – 50%
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Partnership/S-Corp K-1s
IF…
• K-1s do not reflect history of receiving cash
distributions OR distributions consistent with level
of ordinary income
BUT…you can document borrower’s:
• Ownership share
• Access to income (not required if 100% owner)
• Business has adequate liquidity to support withdrawal
of earnings
THEN…
• K-1 income may be included in borrower’s cash flow
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Liquidity Ratio
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Balance Sheet
Case Study pg. 37 Manual pg. 2-25
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Current Ratio
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Section XI, S Corporation K-1 (Form 1120S)
Effect on Cash Flow Analysis
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Case Study pg. 34 Manual pg. 2-21
Form 1120S
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Form 1120S – page 1
Case Study pg. 34 Manual pg. 2-21
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Form 1120S – page 4
Case Study pg. 37 Manual pg. 2-25
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Case Study pg. 38 Manual pg. 2-27
Form 1120S – page 5
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Section XII, Form 1120S
Effect on Cash Flow Analysis
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Case Study pg. 39 Manual pg. 2-29
Form 1120
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Case Study pg. 39 Manual pg. 2-29
Form 1120 – page 1
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Case Study pg. 39 Manual pg. 2-29
Form 1120 – page 1
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Case Study pg. 44
Statement 1
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Case Study pg. 43 Manual pg. 2-37
Form 1120
page 5
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Case Study pg. 43 Manual pg. 2-37
Form 1120 – page 5
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Case Study pg. 45 Manual pg. 2-39
Form 1125-E
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Section XIII, Form 1120
Effect on Cash Flow Analysis
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Cash Flow Analysis Summary
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Purpose of Cash Flow Analysis
Verify qualifying income that is:
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Summary

February 1st changes

Identified common income sources

Discussed taxable income vs. cash flow

Defined key business structures

Analyzed self-employed borrower(s)

Completed cash flow analysis
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www.mgic.com/seb2014
www.mgic.com
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Editable Cash Flow Forms
www.mgic.com/seb2014
NEED HELP? Line-by-line instructions link manual.
Automatically
Calculates Totals
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02/10/2016
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02/10/2016
20
14
TAX YEAR
Thank You
for choosing MGIC
www.mgic.com
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