Unreimbursed Employee Expenses can cause issues with calculating mortgage income
An often overlooked and potential deal killer on mortgage loans is a few pages back in the tax returns on Schedule A called “Employee Business Expenses”. If you have found this article through an online search down the road after it was written, it is probably because you or a client is having an unreimbursed employee expenses issue which is causing an income calculation problem on a mortgage. We hope this is not the case, but at least we want to educate you on the subject and hopefully save your loan now or in the future. When a taxpayer completes their tax return with unreimbursed employee expenses, they are basically telling the IRS the following:
- In order to perform their job, they incurred required expenses
- The employer did not reimburse them for these expenses
- Reduce their taxable income with these deductions
This deduction is first found near the bottom of schedule A and if there is a deduction, then Form 2106 must be completed and will detail what the expenses are.
This expense can be just a few hundred dollars but we have seen recently where borrowers report W2 earnings of $40,000 and then report $32,000 in unreimbursed employee expenses. In some cases this can be a problem and mortgage loan types can treat this differently. Most importantly it can depend on how the borrower is paid. Also not all mortgage loan approvals require tax returns or transcripts of tax returns. But when they do, you can see why it is important that lenders have the tax returns and transcripts early in the process. Below we show you how VA, FHA, USDA, and conventional loans treat these potentially mortgage killer expenses.
How VA Loans Treat Unreimbursed Employee Expenses:
Prior to June 1, 2016, the actual VA guidelines did not address all scenarios for borrowers that may write-off unreimbursed employee expenses. The guidelines only addressed commission income, but not regular salaries, hourly, hourly with overtime, or bonuses.
Per the VA circular clarifying unreimbursed employee expenses, it clarified how to treat unreimbursed employee business expenses on VA loans. So if a borrower receives less than 25% of their income from commissions or receives no commissions at all, then we would not be required to deduct any Unreimbursed Employee Expenses from the borrower’s income. Therefore Unreimbursed Employee Expenses must be deducted from a borrower’s income is if the borrower receives 25% or more of their income from commissions. The only exception to this policy would be when there is an auto lease or loan payment. These are not subtracted from the income because they are considered part of the borrower’s recurring monthly debt obligations. If the borrower reports an auto allowance as part of the qualifying income, the lender must determine if the auto expenses reported on IRS form 2106 should be deducted from income or treated as a liability.
If the reported expense exceeds the automobile allowance, the amount must be deducted from income as a net calculation in Section D on the VA Form 266393.
If the reported expense is less than the automobile allowance, the amount must be treated as net income and added to the Veteran’s monthly income.
How Fannie Mae Conventional Loans Treat Unreimbursed Employee Expenses (form 2106):
Fannie Mae guidelines for a conventional loan does not require that lenders back out the unreimbursed employee expenses when a borrower receives a salary, hourly wage, bonus, receives commissions of less than 25% of their income, or paid hourly plus overtime. The only time that these expenses are backed out of the income is if the borrower receives commissions that are 25% or more of their total income.
How FHA & USDA Loans Treat Unreimbursed Employee Expenses
On FHA and USDA loans, we would need to reduce the borrower’s income by the amount of unreimbursed employee expenses written off no matter what type of income the borrower has. On USDA, this is for debt ratio calculation only and not applicable to the maximum household income limit calculation. So if a borrower is a salaried position and writes off these expenses, we would need to reduce the income by this amount.
So what should you get out of this article? First, always make sure that if you are going to write-off expenses, make sure that they are legitimate expenses so you don’t get in trouble with the IRS. Next, whether you are a borrower or realtor working with a buyer, you can see why it is so important for providing all documentation requested very early in the mortgage process and best if prior to contract. Let’s know if there are issues up-front so you don’t have issues when it is too late in the process to get earnest money, due diligence, or other expenses and time back.