Corporations use IRS Form 1120 to report their taxes. See B3-3.2-02, Business Structures, for more information on corporations.
When funds from a corporation that operates on a fiscal year that is different from the calendar year are used in qualifying a self-employed borrower, the lender must make time adjustments to relate the corporate income to the borrower’s individual tax return, which is on a calendar year basis.
After determining the income available to the borrower for qualifying purposes, the lender must evaluate the overall financial position of the corporation. Ordinary income from the corporation can be used to qualify the borrower only if the following requirements are met:
the business income must be stable and consistent,
the sales and earnings trends must be positive, and
the business must have adequate liquidity to support the borrower’s withdrawals of cash without having severe negative effects.
Items that can be added back to the business cash flow include depreciation, depletion, amortization, casualty losses, net operating losses, and other special deductions that are not consistent and recurring.
The following items should be subtracted from the business cash flow:
meals and entertainment exclusion,
tax liability and amount of any dividends, and
the total amount of obligations on mortgages or notes that are payable in less than one year. These adjustments are not required if there is evidence that these obligations roll over regularly and/or the business has sufficient liquid assets to cover them.