In the past three installments we have explored the common tax filing blunders that can plague self-employed borrowers (part 1); business or rental property owners (part 2); and retirees (part 3) when trying to establish a mortgage. But what if you are neither of the aforementioned? If not self-employed, not a business owner and not retired, your taxes are what they are, right? Not so fast there partner. This Houston mortgage broker has seen many a clever W2 employees commit one or one-too many tax somersaults to save handsomely on their tax return just to be disillusioned at time of application for that mortgage.
Expensing a car loan could hurt you twice (and wheels come flying off)
The tax code allows you to deduct the cost of employing your vehicle in the proportion of its use for business. For example, if you use the car solely for the purpose of conducting business you can deduct as much as 100% of the cost; subject to IRS limits. In cases, where you are employed as say a, sales executive for a piping engineering company, and you constantly find yourself on the road, you have a strong case to deduct a large portion of the wear and tear of your vehicle. Expensing this cost will save you money by reducing your adjusted gross income upon which you are taxed by the IRS. But, do that, and here’s how it’s going to be used against you when establishing a mortgage. The underwriter will assume that the wear and tear of the vehicle is a necessary expense to run your “business”. Therefore, they will reduce your income by that cost when determining your qualifying net income. For example, you earned $100k last year but it cost $333/mo to operate your vehicle to produce your income; therefore your qualifying net income is really $96k. That is a 4% reduction!
But remember, I did say this could hurt you twice. How can that be? Well, here’s the kicker. Let’s say you just purchased the vehicle. The monthly loan cost is $450. Well guess what, when it comes time to qualify for that mortgage the underwriter will not only reduce your income by the cost to operate the vehicle but will also count the monthly debt against you. Why? Because you must service the loan each month. In other words, your income is reliant on the necessary cost of the vehicle and your income must support the debt servicing of the vehicle. Sounds wrong, do not bet on it. Certainly it is not fair, and trust me, I have argued against it, but nine times out of ten you will lose the argument. Here’s the best part. On occasion the company will reimburse you for the cost of the vehicle. The vehicle reimbursement can be used as additional income but you better hope a contractual agreement between you and the company exists because without it the underwriter may not even count it as income and that monthly debt is still going to be considered against you. Now that's sand in anyone's motor.
Meals and entertainment expense really counts twice (heartburn anyone?)
Much like the IRS code that allows you to deduct the cost of a vehicle for business purposes the IRS allows you to deduct the cost of meals and entertainment when used for the purposes conducting business. Nothing wrong here either but beware my ingenious tax wizard. Doing so affects your qualifying income by twice the amount you deducted from your income. Huh? Well here’s how. The IRS code only allows you to deduct ½ your total business meals and entertainment expense. So in reality whatever you identify on your taxes to reduce your adjusted gross income is half the total expense you incurred during the year. Just like the car cost in the example above the underwriter will be left to assume that the meals and entertainment expense was a necessary expense to conduct your business. Therefore, they will reduce your income by that cost when determining your qualifying net income. Continuing the example above, say you earned $100k last year but it cost you $1,250 in meals and entertainment; your qualifying net income is $97.5k. That’s not a typo. Remember, if you took $1,250 in meals and entertainment expense on your taxes it is because you actually had $2,500 in meals and entertainment cost for the full year. Yikes, please pass the tums.
If you ever have any doubt that these tax blunders do not seem fair or are irrational when used against you for the purposes of establishing a mortgage, this Houston mortgage broker could not agree with you more. But this is the game of mortgage underwriting and knowing the rules allow us to win the game for you.
Other common blunders to be discussed in follow-up articles:
1. Unreimbursed employee expenses (part 1)
2. Not declaring profit on self-employment income (part 1)
3. Not declaring rental properties (part 2)
4. Owning more than 25% of a partnership /LLC for which you are an employee (part 2)
5. Retiring without declaring IRA distributions / Pensions / annuities (part 3)
6. Expensing a car loan as a business expense could hurt you twice (part 4)
7. Meals / entertainment expense really counts twice (part 4)
8. Under-declaring income for service jobs (waiter)