Income (or Loss) from a Sole Proprietorship
When a person runs their own business by themselves, it’s called a sole proprietorship. The money this business makes or loses is figured out using a form from the IRS called Schedule C. This form is part of their personal tax return on IRS Form 1040.
If a lender is looking at a borrower’s application for a loan, they might need to adjust the amount of money the borrower says they make or lose. This is because the Schedule C might include money that didn’t come from the business’s regular profits. If the lender thinks this extra money won’t keep coming in, they should not count it when they decide if the borrower can pay back the loan.
For more details on how sole proprietorships work, you can look at another section called “B3-3.2-02, Business Structures”.
Recurring vs. Non-recurring Income and Expenses
Lenders have to figure out if the money a borrower makes will keep coming in regularly or if it was just a one-time thing. Money that isn’t expected to come in again should not be included when the lender calculates how much cash flow the borrower has. This includes any money taken off for things like meals or entertainment that the borrower said was a business expense on Schedule C.
However, there are some costs that businesses write off on their taxes that don’t actually cost the business cash out of pocket. These include depreciation (the decrease in value of business assets like equipment or buildings over time), depletion (the using up of natural resources by a company), business use of a home, amortization (the gradual paying off of debt over time), and casualty losses (losses from sudden events like natural disasters). These costs should be added back into the cash flow calculation because they are not regular expenses that reduce the business’s actual cash on hand.
References
For more details, visit Income or Loss Reported on IRS Form 1040, Schedule C of the Fannie Mae Selling Guide.