Since we are once again at that time of year when we will be preparing our tax returns, I wanted to take the opportunity to share some information on how important tax returns can be in the lending process and to share some incidents I have seen recently that could have resulted in loan denials. Fortunately we were able to assist our borrowers through each of these incidents without significant delay.
In some cases a tax return will not be required for underwriting. However, the lender will require that you complete a form 4506T which is sent to the IRS to obtain a transcript of your filed return. So, even when a tax return is not initially requested, they are often requested after receipt of the transcript if any of the following items are noted: self employed or 1099 income, rental property income, unreimbursed business expenses or any items which don’t correspond with information submitted on paystubs or W-2s. Following are some situations we encountered recently:
Errors and Omissions: W-2s don’t add up to reported income
In this particular instance, the borrower merely made a mathematical error in totaling the w-2’s. He actually reported too much income and overpaid his taxes and did not realize it until we reviewed the documents. While this may seem like a minor error which should not affect the loan process, lenders typically will require that the documents in the file all “make sense” and support one another. The underwriter’s initial response was that the borrower would have to amend his tax return to the correct amount. This would have delayed the loan significantly as it would have also required us to wait until the new return was received and logged in by the IRS so that it could be verified by the lender. This can take 45 days or longer in some cases. We were successful in working with the underwriter to allow the existing tax return to be used since we were not using the additional income to qualify for the loan and it was not a significant dollar difference.
Errors and Omissions: Expenses omitted from return
In a similar incident, the borrower reported rental property income, but did not report the corresponding rental property expenses, once again overstating income. We provided documentation of the omitted expenses, qualified the borrower with the lower income amount and avoided filing an amended return. In both of these cases, these simple oversights nearly caused the borrower to be denied or significantly delayed in obtaining financing.
Tip #1: Review all tax returns carefully or have them prepared by a professional tax preparer.
In a more serious situation, when we obtained verification of the borrower’s return from the IRS, the income reported was about one half of that reported on our borrower’s w-2, and the transcript indicated that the borrower was a single man, while our borrower was married! Upon contacting the borrower, he informed us he had been the victim of identity theft. Once again, underwriter’s place significant importance on being able to verify w-2’s and income through the IRS verification. We resolved this matter by working with the IRS to provide us a manual transcript of the borrower’s actual return which had been filed after the forged return. The underwriter also required the borrower to file a report with local law enforcement. Most people would think to file a police report for property that is stolen, but few think to do the same for identity theft. However, the Federal Trade Commission (FTC) recommends that you not only file a report with the IRS and credit bureaus, but also file a police report. This report also assisted us in clearing up the matter with the underwriter and we even closed on time.
Tip #2: Identity theft is a serious matter and this type of tax return filing is becoming increasingly more common. Take precautions to protect your social security number by disposing properly of all sensitive data and limiting to whom and how you provide this information. Once you become aware that your personal information has been compromised, follow the guidance offered by the FTC and if you are in the process of obtaining financing, make your lender aware of the situation as quickly as possible.
Self-employed borrowers, rental properties and unreimbursed business expenses
Keep in mind that if you are filing returns that include self-employment income, rental properties, and unreimbursed business expenses, the NET income reported is what will be used by the underwriter. Self-employed borrowers often mistakenly believe that the income that will be used to qualify them is their gross income rather than the net amount after they deduct all of their business expenses that they report on their tax returns. Borrowers who own rental properties also make this mistake when calculating their income/loss on rental properties as they neglect to consider the various expenses they write off on their taxes, such as property management, repairs, maintenance, insurance, etc. All of these expenses (other than depreciation) will be deducted by the underwriter from income. In addition if you have a job that requires you to pay significant out of pocket expenses that are not reimbursed to you for travel, supplies, etc., these amounts will also be deducted from your income even if you are a W-2 employee.
TIP #3: If you typically write off expenses on your tax return to offset self-employed income, rental expenses or to claim unreimbursed employee expenses, recognize that these will be deducted from your income and will decrease the amount which you have available to qualify for a loan. In most cases the underwriter will use an average of the last two years for these items. Sit down with your tax preparer and make sure that you understand how your income is being reported. You should also make them aware of all of your financial matters, particularly if you are planning to buy a home in the near future. They may be able to assist you with tax planning strategies that will put you in a better position when that time comes.