How is Sole Proprietor Income Calculated? (IRS Form 1040, Schedule C)

Schedule C – Sole Proprietor

Any income that is from a borrower’s sole proprietorship can be found on Schedule C of Federal Tax Returns. According to Fannie Mae and Freddie Mac guidelines, borrowers need to provide 2 years of recent Federal Tax Returns with Schedule C in order to use the income.  In some cases, 1 year of the most recent tax return with Schedule C is allowed, but additional documentation is required to confirm stability.

 

From Schedule C:
  1. Start by finding the Schedule C pages of the first year of federal tax returns.
  2. Find the Net Profit (or Loss) value (Schedule C, Line 31).
  3. Deduct the non-recurring income or add the non-recurring loss or expense (Schedule C, Line 6).
  4. Add in Depletion value (Schedule C, Line 12).
  5. Add in Depreciation value (Schedule C, Line 13).
  6. Add in the Non-Deductible Meals and Entertainment Exclusion (Schedule C, Line 24b).
  7. Add in the Business Use of Home (Schedule C, Line 30).
  8. Add the Business Mileage Depreciation:
  1. To calculate this value, find the Business Mileage (Schedule C, Page 2, Part IV, Line 44a or on attachment 4562, Line 30) and multiply it by the depreciation rate.  The depreciation rates are provided by Fannie Mae and Freddie Mac.
    1. 2022: $.26, 2021: $.26
  1. Add in the Amortization or Casualty Loss, but only if it is specifically noted (Sched C, Page 2, Part V).
  2. Sum the subtotal of the first year of Schedule C income. 
  3. Repeat steps 2-10 for the next year of tax returns.
  4. To obtain the total monthly qualifying, follow the substeps:
  1. If the income is increasing from year to year, then add the subtotals and divide by 24 months to obtain the Average Monthly Income.
  2. If the income is decreasing from year to year, then divide the most recent year by 12 months to obtain the Average Monthly Income.

If the borrower provides a Profit and Loss statement (PNL) for the current year, you’ll have to do calculations for that as well to determine if it can be used.The PNL is a separate document that comes from the borrower outlining the business they have done up to that point in the year.  

 

From the PNL:
  1. Find the Tenative Profit or Loss Value.
  2. Subtract Other Income.
  3. Add Depletion.
  4. Add Depreciation.
  5. Subtract Deductible Meals and Entertainment.
  6. Sum steps 1-5. This is the YTD Income or Loss.
  7. Divide the YTD by the number of months passed.
  1. To obtain the number of months passed, take the day of the month / days in the month then add the number of months that have fully passed:
    1. Ex: April 15th —> (15/30) + 3 = Months Passed.
  1. The sum of step 7 is the Monthly Amount for the YTD PNL.
  2. Now compare the Monthly Amount for the YTD PNL to the Tax Return Monthly Amount.
  1. If the income is more than the Average Monthly Income from the tax returns, then it is not necessary to use the PNL.
  2. If the income is less than the Average Monthly Income from the tax returns, then the PNL calculation will be your final qualifying monthly income. 

For more information about documentation requirements and income qualifiers for Schedule C Sole Proprietorships,  we encourage you to review the Fannie Mae and Freddie Mac guidelines.