Self Employment/Business Income

By Mike Sprague, Compliance Analyst

We see many files where there is income from a business, or self employment. In some cases, the applicant may list an employer on the application even though they are actually self employed or an independent contractor. If an applicant is paid cash and is responsible for paying their own income taxes, that person should be treated as self employed.

Treating someone as self employed changes how you need to verify income. Instead of using an Employment Verification (EV), you will need to have the Head of Household (HOH) complete a Self Employment Affidavit. You may be able to find this form on your State Housing Authority web site. If no form can be found, you can create your own or use the form provided on Spectrum’s web site (http://www.spectrumlihtc.com/resources/). If you choose to create your own form, be sure to request documentation to accompany the information provided by the applicant.

In the HUD 4350.3, the Appendix 3: Acceptable Forms of Verification provides a list of forms that are acceptable to document self employment:

1. Form 1040 with Schedule C, E, or F – This, of course, is a tax return. Per the 8823 Guide, “A tax return must be filed for all self-employed individuals who operate sole-proprietorship businesses or otherwise report income on Schedule C, regardless of whether the tax payer is reporting a profit or loss.” Schedule C is Profit or Loss From Business (used for Sole Proprietorship), Schedule E is Supplemental Income and Loss (used for rental real estate, royalties, partnerships, S corporations, estates, REMICs, etc.), and Schedule F is Profit or Loss From Farming.

2. Financial Statements of the business – These can either be audited or unaudited. Be sure to obtain an accountant’s calculation of straight-line depreciation expense if accelerated depreciation was used on the tax return or financials.

3. Loan Application – The application must be comprised of income that is derived from business during the preceding 12 month period.

4. For Rental Properties – Copies of rent checks, full copy of the lease, receipts for expenses, or the previously mentioned Schedule E.

Unlike other income sources where gross income is counted, the Net income is counted for Self-Employment. This is the gross income less business expenses, interest on loans, and depreciation expense computed on a straight-line basis. Also count as income any salaries distributed to household members and cash or assets withdrawn by any household members, unless the withdrawal is for reimbursement for investment into the business. If the interest on a loan is for a loan used for capital improvements or to expand the business then it is not included. Other expenses that are excluded are principal payments on loans and any expenses for business expansion or for capital improvements.

EXAMPLE: Tom has applied for a 1 BR apartment and his only source of income is from his Auto Repair business where he earns $2,000 gross per month. He has a loan on the garage that he bought to use for his business. He pays $750 a month on the loan with $550 towards principal and $200 towards interest. Last year he took out a loan to pay for repairs to his roof and pays $100 per month towards this loan. The manager will count $1,800 ($2,000-$200) as income to qualify this household. Since principal payments on loans and any expenses for capital improvements are excluded, the $550 portion of the loan payment and the $100 roof repair loan payments are not counted.

If the net income from a business is negative, the income must be counted as zero. Other income for the household cannot be lowered by negative business income.

EXAMPLE: Fred and Jill have applied for a 1 bedroom apartment. Jill works FT earning $35,000 per year. Fred recently started his own business. In his first full year he has a loss of $5,000 and is projecting to do the same over the next 12 months. Since Jill’s income cannot be reduced by the loss that Fred has incurred, the total income for this household is $35,000.

In most cases, a business owner will have a lot of assets for the business. Any assets that are for the business are not included as assets. If the applicant’s business is real estate and they own properties, then just count any income as business income and do not count the properties as assets. If the applicant is just renting out their house rather than selling it then you would count the income from the rental and you would also count the real estate as an asset.

EXAMPLE: Mark and Debbie have applied for a 1 bedroom apartment. Due to medical reasons, they both have had to cut back their hours at work. Working PT now, Debbie earns $10,000 per year and Mark earns $8,500. Rather than sell their home in a bad market they have decided to rent it out. The Fair Market Value (FMV) of their home is $150,000, and they still owe $165,000 on their mortgage. After expenses, they are receiving $400 per month for rent. The total annual income for this household is $23,300 ($400×12=$4,800+$10,000+$8,500=$23,300), and the real estate asset value would be $0 because they owe more on the mortgage than the current FMV of the home.

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