Who Counts as Self-Employed
Fannie Mae has specific rules about when you're considered self-employed. If you own 25% or more of any partnership, S-corporation, or corporation, you're self-employed for mortgage purposes. This applies even if you also receive a W-2 from that same business.
Sole proprietors are always considered self-employed since they own 100% of their business. You report this income on Schedule C of your personal tax return.
Say you own 30% of an LLC that's taxed as a partnership. Even though you might think of yourself as an employee, Fannie Mae considers you self-employed. Your lender will need to analyze both your personal tax returns and the business tax returns.
If you own less than 25% of a business, you might qualify under regular employment guidelines instead. This can sometimes be easier since the documentation requirements are less extensive.
How Long You Need to Be Self-Employed
The standard requirement is two years of self-employment history. Your tax returns must show at least one year of self-employment income, but lenders prefer seeing two full years to establish income stability.
You can sometimes qualify with less than two years if you meet specific conditions. You need a combined two years of income from your current self-employment plus your previous job in the same or related field. The lender will use whichever income is lower - your new business income or your previous employment income.
A software developer who worked for a company for three years, then started freelancing eight months ago, might qualify. The lender would need to see that freelance income is stable and likely to continue. They'd also want evidence that the borrower's skills transfer well to self-employment.
The lender must write a detailed analysis explaining why they believe your income is stable despite the shorter history.
What Documents You Need to Provide
Your documentation requirements depend on your business structure and how long you've been in business.
For sole proprietors, you need complete signed tax returns (Form 1040) including Schedule C. If your business has existed for less than five years, you need two years of returns. If it's been around five years or more, you might only need one year.
Partnerships require your personal returns plus the business returns (Form 1065) and your Schedule K-1. S-corporations need personal returns, business returns (Form 1120S), Schedule K-1, Form 1125-E, and any W-2s from the business.
Regular corporations need similar documentation but use Form 1120 for the business return.
You also need verification that your business currently exists. This can come from a regulatory agency, phone directory, internet source like the Better Business Bureau, or licensing bureau. The verification must be completed within 120 days of your loan closing.
How Lenders Calculate Your Income
Lenders use Form 91 or a similar worksheet to calculate your average monthly income. They start with the net income from your tax returns, then make adjustments that often work in your favor.
Non-cash expenses like depreciation, depletion, and amortization get added back to your income. These are legitimate business deductions that reduce your taxes but don't represent actual cash leaving your business.
One-time losses also get added back. If you had a casualty loss or other non-recurring expense, the lender won't count it against your ongoing income capacity.
A contractor who shows $60,000 net income on Schedule C but claimed $15,000 in equipment depreciation would have $75,000 in qualifying income. The depreciation reduced taxable income but didn't reduce cash flow.
If your business has mortgages or notes payable within one year, the lender analyzes whether these reduce your qualifying income. If the debt regularly renews or the business has sufficient liquidity to handle it, your income might not be reduced.
Why These Rules Exist
Fannie Mae requires extensive documentation because self-employed income can be less predictable than W-2 income. Business owners have more control over when they recognize income and expenses, which can make tax returns less reliable indicators of actual cash flow.
The two-year requirement exists because one year might not show the full picture. A business might have an unusually good or bad year. Two years of data helps lenders spot trends and assess whether income is stable or declining.
The business analysis requirements protect both you and the lender. If your business is struggling financially, taking on mortgage payments could create problems. The lender needs to verify that your business can continue supporting your income while you pay the mortgage.
Income Fluctuation Analysis
If your income has changed significantly over the past two years, the lender must determine whether the income used for qualification is likely to continue. Increasing income generally isn't a problem, but declining income requires careful analysis.
The lender needs documentation and justification to support their determination that your income is stable. They might need additional years of tax returns if your income fluctuates significantly.
A real estate agent whose commission income dropped 30% from one year to the next would face additional scrutiny. The lender might look at market conditions, the agent's client base, or other factors that could explain the decline.
If the analysis shows your income is trending downward without good explanation, the lender might not be able to use your full current income for qualification.
When You Don't Need Full Documentation
If you have self-employment income but it's not your primary source of income, the documentation requirements are lighter. You need another source of income that qualifies you for the mortgage without using the self-employment income.
In this case, the lender only needs pages 1 and 2 of your tax return plus relevant schedules to check for business losses that might affect your qualifying income.
A teacher who also runs a small tutoring business would fall into this category. As long as the teaching salary qualifies them for the mortgage, the lender doesn't need complete business documentation for the tutoring income.
However, if the business shows a loss, the lender must analyze whether that loss affects your ability to repay the mortgage.
Using Business Assets for Closing
If you plan to use business funds for your down payment or closing costs, the lender must verify that withdrawing these funds won't hurt your business operations.
They'll review your business financial statements and recent bank statements to ensure the business remains viable after the withdrawal. The analysis must be documented in writing.
A successful restaurant owner wanting to use $50,000 from business accounts for a down payment would need to show the business has sufficient remaining capital to operate normally.
This requirement protects against situations where using business funds for a home purchase could cause the business to fail, eliminating the income needed to pay the mortgage.
Common Complications
Several situations can complicate self-employment income analysis. If you changed your business structure recently - say from sole proprietorship to S-corporation - the lender treats this as potentially creating a new business unless specific conditions are met.
Your ownership percentage must remain the same, and there can't be other significant changes like location, products, or services. If these conditions aren't met, you might need to start over with the two-year history requirement.
Tax returns on extension create another complication. If your most recent tax returns aren't available, the lender needs additional documentation to verify your income continues at the same level. This might include recent financial statements, business bank statements, or quarterly tax filings.
Rental income from partnerships or S-corporations gets special treatment. All rental income reported on Form 8825 is considered self-employment income regardless of your ownership percentage or personal liability on the property loans.
References
For the official guidelines, see 5304.1: Stable monthly income and documentation requirements for self-employed Borrowers in the Fannie Mae Selling Guide.
Mortgage guidelines change. Stay current.
Fannie Mae and Freddie Mac update their rules several times a year. Get notified when changes affect your mortgage eligibility, required documents, or loan terms.
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Original Freddie Mac Guideline Text
This chapter provides the requirements to determine the appropriate qualifying income for a self-employed Borrower.
This section contains requirements and guidance related to:
Self-employed Borrower definition, business structure and verification of ownership interest percentage
®
Business income: access and use
Income calculation and fluctuation analysis
Additional supporting documentation for business and income analysis
Business structure change
Internal Revenue Service (IRS) Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation
Self-employment income not used for qualification
Business assets used for closing
Verification of current existence of the business
Section 5301.1
for additional information with respect to income stability and continuance.
(a)
Self-employed Borrower definition, business structure and verification of ownership interest percentage
The business structure determines the reporting method of both the business and self-employment income to the IRS. The federal income tax returns for the business usually document the percentage of ownership interest in the business.
The following table contains requirements and guidance for determining self-employment and verifying the Borrower's business ownership percentage:
1
Self-employment definition and verification of ownership interest percentage
Partnerships, S-corporations and corporations
A Borrower who has an ownership interest of 25% or more in a Partnership (general or limited), S-corporation and/or corporation is considered to be self-employed
The ownership interest percentage must be verified by a review of the federal income tax returns for the business, including the IRS Schedule K-1(s) or IRS Form 1125-E, Compensation of Officers. If these documents do not provide this information, the ownership interest percentage must be verified with a letter from the accountant for the business or similar documents.
If the Borrower has ownership interest in one or more businesses, but the ownership interest is not 25% or more for any business, refer to the requirements and guidance in
Section 5303.1(e)
for employment/income characteristics or use the requirements in this chapter
Sole proprietorships and Schedule C
Sole proprietorships are unincorporated businesses. A sole proprietor owns 100% of the business and reports the income and expenses from that business on Schedule C of the federal individual income tax return. There is no associated federal business tax return.
Note: For IRS Form 1099 income received for services performed and reported on Schedule C, Sellers may refer to
Section 5303.1(e)
for additional information with respect to determining whether this income may be treated as non-self-employed income.
1
If the Seller is aware of a business structure change in the past five years (e.g., sole proprietorship to S-Corporation), refer to the business structure change requirements in
Section 5304.1(i)
.
(b)
Loan Product Advisor
The Seller must indicate to Loan Product Advisor that a Borrower is self-employed when the Borrower meets Freddie Mac's definition of self-employed as stated above in
Section 5304.1(a)
. This is required in all cases where the self-employment income and/or loss is used to determine the Borrower's stable monthly income for qualifying.
For Borrowers with self-employed income assessed using automated income assessment using tax data, refer to
Section 5304.2
.
(c)
Self-employment history requirements
The following table contains requirements and guidance pertaining to self-employment history:
Length of history requirement
In most cases, a two-year history of current self-employment is required to ensure income stability. The self-employment must be documented on
Form 65, Uniform Residential Loan Application,
and verified in accordance with this chapter.
Self-employment less than two years
In certain instances, a Borrower may not have a current two-year history of self-employment; yet, the income and employment may still be considered stable.
When the Borrower has been self-employed for less than two years, the Seller must obtain supporting documentation sufficient to determine whether the income is stable. At a minimum, the Seller must:
Consider and evaluate the Borrower's experience in the business
Document that the Borrower has a combined two-year history of receipt of income from the current self-employment and the prior job in the same or similar occupation or industry
Determine qualifying income by using the lesser of:
The stable monthly income from the new business, or
The stable monthly income earned in the previous occupation
Include a written analysis justifying the determination of stability of the income in the Mortgage file
Consider the overall layering of risk, including the Borrower's demonstrated ability to repay obligations
Analysis of current business activity through a review of the year-to date (YTD) financial statement and/or the most recent three months of business bank statements may provide support to this evaluation.
Minimum history of receipt of income
The Borrower's federal income tax returns must reflect at least one year of self-employment income
Geographical relocation
If the Borrower is relocating to a different geographic area, at a minimum the Seller must:
Consider and evaluate the acceptance of the company's service or products in the marketplace. Additional information, such as market studies or relevant industry research, may support this evaluation.
Provide a written analysis justifying the Borrower's income will continue at the same level in the new location
(d)
Business review and analysis
The following table contains requirements and guidance pertaining to review and analysis of the business that produces the stable monthly income for the Borrower.
Business review and analysis
The Seller's analysis of the business must support that the business has sufficient liquidity and is financially capable of producing stable monthly income for the Borrower.
The analysis must include a review of the business tax returns
The Seller's review must include, at a minimum, an analysis of gross receipts or sales, cost of goods sold and gross profits. All should be typical for the type of business and reflect consistent year over year trends. In addition, the business expenses should be reasonable for the type of business activity and level of business income. Business tenure should be considered.
The Seller may determine that review and analysis of the business financial statements, business asset statements, and in the case of Partnerships and S-corporations, an analysis of the historical cash distributions, is necessary to establish the financial and liquidity standing of the business. In addition, the Seller may calculate and consider the liquidity ratios of the business using generally accepted accounting practices when analyzing the liquidity of the business.
(e)
Business income: access and use
The following table contains requirements and guidance pertaining to verification of access to and use of business income:
Access to business income
Documentation is not required to verify access to business income for the following:
Sole proprietorships
Ordinary income, net rental real estate income, other net rental income and guaranteed payments received from partnerships and S-corporations
W-2 income received from S-corporations and corporations,
Corporations, if the Borrower holds 100% ownership interest
Documentation is required to verify access to business income as follows:
If business income not reported on the Borrower's federal individual income tax returns is being used to qualify and none of the categories above apply for when documentation is not required, then the Seller must verify that the Borrower's legal right to the business income that is used as stable monthly income is not encumbered, restricted or prevented by the corporate resolution, partnership agreement, or other comparable document.
Use of business income
Use of business income reported on the Borrower's federal individual income tax returns
For sole proprietorships, stable monthly income must be based on the income reported on Schedule C of the Borrower's federal individual income tax returns
For partnerships and S-corporations, stable monthly income may be based on the Borrower's proportionate share of income (e.g., ordinary income, guaranteed payments) carried from the Form 1065 or 1120 S, through the Schedule K-1 and onto the Borrower's federal individual income tax returns. Although cash distributions reported on the Schedule K-1 may not be used as qualifying income, they may be used to establish business liquidity and access to business funds, provided they are reasonably consistent with the ordinary income.
For S-corporations and corporations, stable monthly income may be based on the income reported on the Borrower's W-2 from the business. The corporate tax returns and Form 1125-E if applicable, must be reviewed for confirmation of the Borrower's W-2 income from the business.
Use of business income not reported on the Borrower's federal individual income tax returns
Income reported on the business tax returns but not on the personal tax returns may be considered as stable monthly income, provided the Seller's analysis confirms that based on the financial strength of the business, the use of these funds as personal income would not have a detrimental impact on the business
(f)
Income calculation and fluctuation analysis
The following table contains requirements and guidance pertaining to self-employed income calculation and fluctuation analysis:
Income calculation and fluctuation analysis
Income calculation
The Seller's calculation of a self-employed Borrower's average monthly income must be based on a review of the Borrower's complete federal individual income tax returns (Form 1040), including W-2s and Schedule K-1's (if applicable), and the Borrower's complete federal income tax returns for the business (Forms 1120, 1120 S and 1065), when applicable.
The Seller must analyze the tax returns and document the calculation of the Borrower's self-employed income on
Form 91, Income Calculations
, or a similar alternative form.
If the self-employment history is less than two years:
Section 5304.1(c)
for additional requirements.
Income calculation adjustments (examples)
The following list includes common examples of items that may be considered for inclusion in income when performing the self-employed income calculations on
Form 91
, or a similar alternative form.
Non-cash deductions
(e.g., depreciation, depletion, amortization)
(e.g., casualty loss)
Loss carry-over(s)
from previous tax years
Mortgages and notes payable in less than one year
The Seller must analyze the terms of the Mortgages and notes payable in less than one year and determine whether the income should be reduced by the debt when performing the income analysis
The analysis must include factors such as whether the business has sufficient liquidity to pay off the debt without a negative impact to the business, if the business type is indicative of debt that would continually roll over, and/or if the debt is a line of credit that is consistently renewable. If these factors are present, the income does not need to be reduced by the debt when performing the income analysis.
Income fluctuation
As part of the analysis, the Seller must consider whether the Borrower's self-employed income has increased or decreased over the previous two years when the Seller's analysis includes a review of documentation covering a history greater than one year
If the analysis reflects that the Borrower's income has significantly increased or decreased:
The Seller must provide sufficient documentation and justification to support the determination that the income used to qualify the Borrower is stable and likely to continue for the next three years
It may be necessary to obtain additional years' tax returns when the Borrower's self-employment income fluctuates in order to determine the stability of the income.
5304.1(g)
for more information about additional supporting documentation for business and income analysis.
(g)
Additional supporting documentation for business and income analysis
The following table contains requirements and guidance pertaining to additional supporting documentation that may be used to determine whether a borrower has stable monthly income when evaluating and determining various components of self-employment analysis, including, but not limited to, business liquidity, continued income stability when tax returns are on extension or are over 120 days old, evaluating a newer business and the impact of business fund withdrawals.
Additional supporting documentation for business and income analysis
Business financial statements
Business financial statements typically consist of a profit and loss statement and a balance sheet for the business that cover a specified period of time (e.g., YTD, quarterly, annual).
Financial statements for the business may be prepared by multiple parties, including but not limited to, the Certified Public Accountant, accountant or tax preparer that prepares the tax returns for the business, or the Borrower
Financial statements may not be used for the calculation of stable monthly income (unless audited); however, they may provide additional support for the Seller's business and income analysis
Financial statements for the business may be used to assist in evaluating and determining various components of self-employment analysis, including, but not limited to, business liquidity, continued income stability when tax returns are on extension or are over 120 days old, evaluating a newer business and the impact of business fund withdrawals
Business and/or individual tax return(s) - most recent calendar year not yet available
If the Borrower’s federal individual and/or business income tax returns for the most recent calendar year, or fiscal year as applicable, are not available (e.g., Borrower and/or Borrower’s business filed an IRS extension, tax returns are not yet filed with the IRS), examples of factors and documentation to consider when using older tax returns to determine continued income stability include, but are not limited to, the following:
Business review and analysis of current business activity through a review of the most recent financial statement(s) that cover the period since the last tax return filing(s)
Business review and analysis of current business activity through a review of at least the most recent three months of business bank statements
Signed IRS Form 941, Employer’s Quarterly Federal Tax Return, for the prior calendar year and current calendar year quarter(s) that supports wages and other compensation documented on the most recent business tax return
Review of tax liability reported with IRS tax filing extension(s) (e.g., IRS Form 4868, IRS Form 7004) to determine consistency with tax liability reported on prior year(s) tax return(s)
Review of W-2s, 1099s and/or K-1s from the most recent calendar year, if available
If the continued stability of the income cannot be determined, then the Borrower’s federal individual and/or business income tax returns from the most recent calendar year may need to be obtained to make the determination.
Section 5302.4(b)
for additional information about age of tax return requirements, including, but not limited to, the requirement to document evidence of continued income stability using at least one of the examples listed above when the Seller has not obtained the IRS confirmation verifying tax transcript(s) are not yet available for the business tax return(s).
(h)
Section 5401.2(c)(v)
for requirements for self-employed Borrower’s debt paid by the Borrower's business.
(i)
Business structure change
The following table contains requirements and guidance pertaining to a business structure change:
Business structure change
If the Borrower changed their business structure (e.g., sole proprietorship to S-corporation, S-corporation to corporation), the Borrower's ownership interest percentage must not change in order for the current and prior business structures to be considered the same business. Additionally, the Seller must not have knowledge, information or documentation that other changes occurred (e.g., change of products and/or services, location), and there must be no indication the change had a negative impact on business revenue or expenses. The Seller must document their evaluation in the written income analysis. If any of these requirements are not met, then the current and prior business structures must be treated as different businesses.
(j)
IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation
The following table contains requirements and guidance pertaining to rental real estate income and expenses reported on IRS Form 8825:
Rental real estate income and expenses reported on IRS Form 8825
Requirements and guidance
IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation
All rental real estate income and expenses reported on IRS Form 8825 for partnerships and S-corporations are to be treated as self-employment income, regardless of whether or not the Borrower is personally obligated on the Note and regardless of the Borrower's percentage of ownership interest in the partnership or S-corporation. The requirements of
Section 5401.2(c)(v)
are not applicable.
Form 91
for the appropriate treatment and calculation of the Borrower's proportionate share of the net rental real estate income or loss.
(k)
Self-employment income not used for qualification
The following table contains requirements and guidance pertaining to self-employment income not used for qualification:
Self-employment income not used for qualification
Form 65
(or other documentation) but not used to qualify
The Seller is not required to obtain any additional documentation or evaluate the income or loss from the self-employment for each Borrower on the Mortgage who:
Has a primary source of income, other than self-employment, used for qualifying for the Mortgage (e.g., salaried income from primary employment), and
Is self-employed and self-employment income is a secondary source of income
For each Borrower on the Mortgage who is self-employed and does not have another source of income that is used in qualifying for the Mortgage, the following requirements apply:
The Seller must obtain pages 1 and 2 of the Borrower's federal individual income tax returns, and the applicable schedules (e.g., Schedule C, Schedule E), to determine if there is a business loss that may have an impact on the stable monthly income. Refer to
Section 5302.4(b)
for information about using IRS tax transcripts to meet certain portions of this requirement.
If a business loss is reported and the Borrower qualifies with the loss, then the Seller is not required to obtain any additional documentation relating to the business loss
If a business loss is reported and the Borrower does not qualify with the loss, then the Seller must perform a business and income analysis to determine whether depreciation adjustments or other factors such as business closure or evidence of a one-time non-recurring event justify a reduction of the reported loss when calculating the stable monthly income. The Seller must obtain additional documentation needed in order to fully evaluate the loss and support the analysis (e.g., business tax returns (final or otherwise), evidence of a one-time non-recurring event).
If the tax returns or other documentation in the Mortgage file (e.g., IRS tax transcripts, additional Schedule K-1's) reflect positive income from self-employment but that income is not used to qualify, additional documentation (e.g., complete business or federal individual income tax return(s)) is not required
(l)
Business assets used for closing
The following table contains requirements and guidance pertaining to business assets used for closing:
Business assets used for closing
Withdrawals of assets from the business may have a negative impact on the ability of the business to continue operating. When business assets are being used for the Down Payment, Closing Costs and/or reserves, the Seller must determine that the withdrawal of the funds will not have a detrimental effect on the business. In addition to a review and analysis of the personal and business tax returns, the Seller may review and analyze the current financial statement and/or the last three months of the business bank statements to confirm the deposits, withdrawals and balances are supportive of a viable business and are aligned with the level and type of income and expenses reported on the business tax returns.
The factors contributing to the determination that the withdrawal will not negatively impact the business must be included on the Seller's written analysis of the income source and amount
The business assets must be verified in accordance with the documentation requirements in
,
5102.4
and
5501.3
.
(m)
Verification of current existence of the business
The following table contains requirements and guidance pertaining to verification of current existence of the business:
Verification of current existence of the business
Requirements and guidance
Verification of current existence of business
Verification of the current existence of the business is required when positive income from the business is used as stable monthly income.
Acceptable third-party sources
Acceptable third-party sources include, but are not limited to:
Phone directory
Internet source (e.g., Better Business Bureau)
Applicable licensing bureau
Verification of current existence of the business obtained verbally from an acceptable third-party source must be documented and include all of the following:
Name and address of the business
Name of individual and entity contacted to obtain the verification
Date information verified
Name and title of the individual who completed the verification for the Seller
Alternative sources
The Seller may consider alternative sources if the above are not available, such as:
Preparer of the tax returns for the business (e.g., accountant), provided the preparer has an arm's length relationship with the Borrower
At least one months' business bank statement that supports the current existence of the business and the level and type of income and expenses reported on the business tax returns
Date requirements
The verification must be completed prior to the Delivery Date, but no more than 120 days prior to the Note Date.
(n)
Documentation requirements
The Seller must establish and calculate the stable monthly income using at least the following required documentation. Additional documentation may be needed to support income stability, as described within this chapter.
Form 91
or a similar alternative form (e.g., Income Calculation Report or Freddie Mac Income Calculator Certificate, both as described in
)
Verification of the current existence of the business as described in
Section 5304.1(m)
Federal income tax returns, as required in the table below, including all applicable schedules and forms must reflect at least 12 months of self-employed income
Verification of how long the business has been in existence:
For partnerships, S-corporations and corporations, the federal income tax return(s) for the business must indicate the number of years that the business has been in existence
For sole proprietorships, the federal individual income tax return(s) and any other documentation or information received must not contradict the number of years that the business has been in existence as documented on
Business structure
Streamlined Accept and Standard Documentation levels
Business in existence greater than or equal to five years
1
Business in existence less than five years
Sole proprietorship
Complete signed federal individual (Form 1040) income tax return for the most recent year
Complete signed federal individual (Form 1040) income tax returns for the most recent two years
Partnership
Complete signed federal individual and partnership (Form 1065) income tax returns, including the Schedule K-1(s) for the most recent year
Complete signed federal individual and partnership (Form 1065) income tax returns, including the Schedule K-1(s) for the most recent two years
S-corporation
Complete signed federal individual and S-corporation (Form 1120S) income tax returns, including the Schedule K-1(s), Form 1125-E and W-2(s) if applicable, for the most recent year
Complete signed federal individual and S-corporation (Form 1120S) income tax returns, including the Schedule K-1(s), Form 1125-E and W-2(s) if applicable, for the most recent two years
Corporation
Complete signed federal individual and corporation (Form 1120) income tax returns, including Form 1125-E and W-2(s) as applicable, for the most recent year
Complete signed federal individual and corporation (Form 1120) income tax returns, including Form 1125-E and W-2(s) as applicable, for the most recent two years
1
The Borrower must be self-employed (i.e., have an ownership interest of 25% or more) in the same business for at least five years
