In the last four years we’ve seen many that have lost their jobs starting their own businesses. Of course, with being self-employed there comes that extra “self-employment” tax, so it can be very appealing to the small business owner to not claim income earned in cash rather than check or credit. In fact, I’ve seen many service businesses that offer discounts to their customers for cash rather than credit card or check because what doesn’t go through their bank accounts didn’t really happen, right?
The problem with this is that when it comes to getting a mortgage loan to refinance or buy a home, it’s what’s on the tax returns that qualifies the borrower for the loan. Cash not disclosed to the IRS can’t be used because it can’t be proved.
Another common method used to reduce the tax liability of the self-employed is to write-off as many expenses as possible as businesses expenses. While this may reduce the small business owner’s tax liability, qualifying for a mortgage loan is based on the taxable income reported on Line 31 of the Schedule C form, not the gross amount on Line 7.
This does put the self-employed borrower at a disadvantage compared to w W-2’d borrower, especially if they have a home office since many items that are paid also by a W-2’s borrower (cell phone, land line, internet, auto leases, etc.) is expensed by the self-employed, and thus reduces their taxable income even though both borrowers pay the same for those monthly expenses.
I’ve had many clients here in Utah that legitimately made good money, but to minimize taxes itemized themselves down to almost no income. Sure is was a great idea at first, but now they don’t qualify for anywhere near the quality of home they can actually afford.
The solution? Report fairly and accurately on your taxes. It hurts in the pocket book a bit, but when the time comes to prove your income to buy a home, you’ll be glad you did. Talk to an accountant or other tax professional to get good advice on how to maximize your income and minimize your taxes.