Freddie Mac Single-Family Seller/Servicer Guide 5304.1 — Stable monthly income and documentation requirements for self-employed Borrowers

This chapter provides the requirements to determine the appropriate qualifying income for a selfemployed Borrower. This section contains requirements and guidance related to: ■ Self-employed Borrower definition, business structure and verification of ownership interest percentage ■ Loan Product Advisor® ■ Self-employment history requirements ■ Business review and analysis ■ Business income: access and use ■ Income calculation and fluctuation analysis ■ Additional supporting documentation for business and income analysis ■ Borrower debt paid by business ■ Business structure change ■ Internal Revenue Service (IRS) Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation ■ Self-employment income not used for qualification ■ Business assets used for closing ■ Verification of current existence of the business ■ Documentation requirements Refer to Section 5301.1 for additional information with respect to income stability and continuance.

(a) Self-employed Borrower definition, business structure and verification of ownership interest percentage The business structure determines the reporting method of both the business and selfemployment income to the IRS. The federal income tax returns for the business usually document the percentage of ownership interest in the business. The following table contains requirements and guidance for determining self-employment and verifying the Borrower’s business ownership percentage: Business structure1 Self-employment definition and verification of ownership interest percentage Partnerships, S-corporations and corporations ■ A Borrower who has an ownership interest of 25% or more in a Partnership (general or limited), Scorporation and/or corporation is considered to be self-employed ■ The ownership interest percentage must be verified by a review of the federal income tax returns for the business, including the IRS Schedule K-1(s) or IRS Form 1125-E, Compensation of Officers. If these documents do not provide this information, the ownership interest percentage must be verified with a letter from the accountant for the business or similar documents. ■ If the Borrower has ownership interest in one or more businesses, but the ownership interest is not 25% or more for any business, refer to the requirements and guidance in Section 5303.1(e) for employment/income characteristics or use the requirements in this chapter Sole proprietorships and Schedule C Sole proprietorships are unincorporated businesses. A sole proprietor owns 100% of the business and reports the income and expenses from that business on Schedule C of the federal individual income tax return. There is no associated federal business tax return. Note: For IRS Form 1099 income received for services performed and reported on Schedule C, Sellers may refer to Section 5303.1(e) for additional information with respect to determining whether this income may be treated as non-self-employed income. Business structure1 Self-employment definition and verification of ownership interest percentage Schedule F, Profit or Loss From Farming A Borrower who has an ownership interest of 25% or more in a business is considered to be self-employed. The business structure and ownership interest percentage for farm income reported on Schedule F is based on how the income has been reported to the IRS. Examples include: ■ Individual proprietor (100% ownership interest) ■ Qualified joint venture (ownership interest based on respective interest(s)/share(s) reported on each Schedule F) ■ Partnership (refer to partnerships row above) 1If the Seller is aware of a business structure change in the past five years (e.g., sole proprietorship to SCorporation), refer to the business structure change requirements in Section 5304.1(i).

(b) Loan Product Advisor The Seller must indicate to Loan Product Advisor that a Borrower is self-employed when the Borrower meets Freddie Mac’s definition of self-employed as stated above in Section 5304.1(a). This is required in all cases where the self-employment income and/or loss is used to determine the Borrower’s stable monthly income for qualifying. For Borrowers with self-employed income assessed using automated income assessment using tax data, refer to Section 5304.2.

(c) Self-employment history requirements The following table contains requirements and guidance pertaining to self-employment history: Self-employment history Topic Requirements and guidance Length of history requirement In most cases, a two-year history of current self-employment is required to ensure income stability. The self-employment must be documented on Form 65, Uniform Residential Loan Application, and verified in accordance with this chapter. Self-employment less than two years In certain instances, a Borrower may not have a current twoyear history of self-employment; yet, the income and Self-employment history Topic Requirements and guidance employment may still be considered stable. When the Borrower has been self-employed for less than two years, the Seller must obtain supporting documentation sufficient to determine whether the income is stable. At a minimum, the Seller must: ■ Consider and evaluate the Borrower’s experience in the business ■ Document that the Borrower has a combined two-year history of receipt of income from the current selfemployment and the prior job in the same or similar occupation or industry ■ Include a written analysis justifying the determination of stability of the income in the Mortgage file ■ Consider the overall layering of risk, including the Borrower’s demonstrated ability to repay obligations Analysis of current business activity through a review of the year-to date (YTD) financial statement and/or the most recent three months of business bank statements may provide support to this evaluation. Minimum history of receipt of income The Borrower’s federal income tax returns must reflect at least one year of self-employment income Geographical relocation If the Borrower is relocating to a different geographic area, at a minimum the Seller must: ■ Consider and evaluate the acceptance of the company’s service or products in the marketplace. Additional information, such as market studies or relevant industry research, may support this evaluation. ■ Provide a written analysis justifying the Borrower’s income will continue at the same level in the new location

(d) Business review and analysis The following table contains requirements and guidance pertaining to review and analysis of the business that produces the stable monthly income for the Borrower. Business review and analysis Topic Requirements and guidance Business review and analysis The Seller’s analysis of the business must support that the business has sufficient liquidity and is financially capable of producing stable monthly income for the Borrower. ■ The analysis must include a review of the business tax returns ■ The Seller’s review must include, at a minimum, an analysis of gross receipts or sales, cost of goods sold and gross profits. All should be typical for the type of business and reflect consistent year over year trends. In addition, the business expenses should be reasonable for the type of business activity and level of business income. Business tenure should be considered. ■ The Seller may determine that review and analysis of the business financial statements, business asset statements, and in the case of Partnerships and S-corporations, an analysis of the historical cash distributions, is necessary to establish the financial and liquidity standing of the business. In addition, the Seller may calculate and consider the liquidity ratios of the business using generally accepted accounting practices when analyzing the liquidity of the business.

(e) Business income: access and use The following table contains requirements and guidance pertaining to verification of access to and use of business income: Business income: access and use Topic Requirements and guidance Access to business income Documentation is not required to verify access to business income for the following: ■ Sole proprietorships ■ Ordinary income, net rental real estate income, other net rental income and guaranteed payments received from partnerships and S-corporations ■ W-2 income received from S-corporations and corporations, ■ Corporations, if the Borrower holds 100% ownership interest Documentation is required to verify access to business income as follows: If business income not reported on the Borrower’s federal individual income tax returns is being used to qualify and none of the categories above apply for when documentation is not required, then the Seller must verify that the Borrower’s legal right to the business income that is used as stable monthly income is not encumbered, restricted or prevented by the corporate resolution, partnership agreement, or other comparable document. Use of business income Use of business income reported on the Borrower’s federal individual income tax returns ■ For sole proprietorships, stable monthly income must be based on the income reported on Schedule C of the Borrower’s federal individual income tax returns ■ For partnerships and S-corporations, stable monthly income may be based on the Borrower’s proportionate share of income (e.g., ordinary income, guaranteed payments) carried from the Form 1065 or 1120 S, through the Schedule K-1 and onto the Borrower’s federal individual income tax returns. Although cash distributions reported on the Schedule K-1 may not be used as qualifying income, they may be used to establish business liquidity and access to business funds, provided they are reasonably consistent with the ordinary Business income: access and use Topic Requirements and guidance income. ■ For S-corporations and corporations, stable monthly income may be based on the income reported on the Borrower’s W-2 from the business. The corporate tax returns and Form 1125-E if applicable, must be reviewed for confirmation of the Borrower’s W-2 income from the business. Use of business income not reported on the Borrower’s federal individual income tax returns Income reported on the business tax returns but not on the personal tax returns may be considered as stable monthly income, provided the Seller’s analysis confirms that based on the financial strength of the business, the use of these funds as personal income would not have a detrimental impact on the business

(f) Income calculation and fluctuation analysis The following table contains requirements and guidance pertaining to self-employed income calculation and fluctuation analysis: Income calculation and fluctuation analysis Topic Requirements and guidance Income calculation The Seller’s calculation of a self-employed Borrower’s average monthly income must be based on a review of the Borrower’s complete federal individual income tax returns (Form 1040), including W-2s and Schedule K-1’s (if applicable), and the Borrower’s complete federal income tax returns for the business (Forms 1120, 1120 S and 1065), when applicable. The Seller must analyze the tax returns and document the calculation of the Borrower’s self-employed income on Form 91, Income Calculations, or a similar alternative form. If the self-employment history is less than two years: Refer to Section 5304.1(c) for additional requirements. Income calculation adjustments (examples) The following list includes common examples of items that may be considered for inclusion in income when performing the self-employed income calculations on Form 91, or a similar alternative form. ■ Non-cash deductions (e.g., depreciation, depletion, amortization) ■ Non-recurring losses (e.g., casualty loss) ■ Loss carry-over(s) from previous tax years ■ Mortgages and notes payable in less than one year • The Seller must analyze the terms of the Mortgages and notes payable in less than one year and determine whether the income should be reduced by the debt when performing the income analysis • The analysis must include factors such as whether the business has sufficient liquidity to pay off the debt without a negative impact to the business, if the business type is indicative of debt that would continually roll over, and/or if the debt is a line of credit that is consistently renewable. If these factors are present, the income does not need to be reduced by the debt when performing the income analysis. Income calculation and fluctuation analysis Topic Requirements and guidance Income fluctuation As part of the analysis, the Seller must consider whether the Borrower’s self-employed income has increased or decreased over the previous two years when the Seller’s analysis includes a review of documentation covering a history greater than one year If the analysis reflects that the Borrower’s income has significantly increased or decreased: ■ The Seller must provide sufficient documentation and justification to support the determination that the income used to qualify the Borrower is stable and likely to continue for the next three years ■ It may be necessary to obtain additional years’ tax returns when the Borrower’s self-employment income fluctuates in order to determine the stability of the income. Refer to Section 5304.1(g) for more information about additional supporting documentation for business and income analysis.

(g) Additional supporting documentation for business and income analysis The following table contains requirements and guidance pertaining to additional supporting documentation that may be used to determine whether a borrower has stable monthly income when evaluating and determining various components of self-employment analysis, including, but not limited to, business liquidity, continued income stability when tax returns are on extension or are over 120 days old, evaluating a newer business and the impact of business fund withdrawals. Additional supporting documentation for business and income analysis Topic Requirements and guidance Business financial statements Business financial statements typically consist of a profit and loss statement and a balance sheet for the business that cover a specified period of time (e.g., YTD, quarterly, annual). ■ Financial statements for the business may be prepared by multiple parties, including but not limited to, the Certified Public Accountant, accountant or tax preparer that prepares the tax returns for the business, or the Borrower ■ Financial statements may not be used for the calculation of stable monthly income (unless audited); however, they may provide additional support for the Seller’s business and income analysis ■ Financial statements for the business may be used to assist in evaluating and determining various components of self-employment analysis, including, but not limited to, business liquidity, continued income stability when tax returns are on extension or are over 120 days old, evaluating a newer business and the impact of business fund withdrawals Business and/or individual tax return(s) - most recent calendar year not yet available If the Borrower’s federal individual and/or business income tax returns for the most recent calendar year, or fiscal year as applicable, are not available (e.g., Borrower and/or Borrower’s business filed an IRS extension, tax returns are not yet filed with the IRS), examples of factors and documentation to consider when using older tax returns to determine continued income stability include, but are not limited to, the following: ■ Business review and analysis of current business activity through a review of the most recent financial statement(s) that cover the period since the last tax return filing(s) ■ Business review and analysis of current business activity through a review of at least the most recent three months of business bank statements ■ Signed IRS Form 941, Employer’s Quarterly Federal Tax Return, for the prior calendar year and current calendar year quarter(s) that supports wages and other compensation documented on the most recent business tax return ■ Review of tax liability reported with IRS tax filing extension(s) (e.g., IRS Form 4868, IRS Form 7004) to determine consistency with tax liability reported on prior year(s) tax return(s) ■ Review of W-2s, 1099s and/or K-1s from the most recent calendar Additional supporting documentation for business and income analysis Topic Requirements and guidance year, if available If the continued stability of the income cannot be determined, then the Borrower’s federal individual and/or business income tax returns from the most recent calendar year may need to be obtained to make the determination. Note: Refer to Section 5302.4(b) for additional information about age of tax return requirements, including, but not limited to, the requirement to document evidence of continued income stability using at least one of the examples listed above when the Seller has not obtained the IRS confirmation verifying tax transcript(s) are not yet available for the business tax return(s).

(h) Borrower debt paid by business Refer to Section 5401.2(c)(v) for requirements for self-employed Borrower’s debt paid by the Borrower’s business.

(i) Business structure change The following table contains requirements and guidance pertaining to a business structure change: Business structure change Topic Requirements and guidance Business structure change If the Borrower changed their business structure (e.g., sole proprietorship to S-corporation, S-corporation to corporation), the Borrower’s ownership interest percentage must not change in order for the current and prior business structures to be considered the same business. Additionally, the Seller must not have knowledge, information or documentation that other changes occurred (e.g., change of products and/or services, location), and there must be no indication the change had a negative impact on business revenue or expenses. The Seller must document their evaluation in the written income analysis. If any of these requirements are not met, then the current and prior business structures must be treated as different businesses.

(j) IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation The following table contains requirements and guidance pertaining to rental real estate income and expenses reported on IRS Form 8825: Rental real estate income and expenses reported on IRS Form 8825 Topic Requirements and guidance IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation All rental real estate income and expenses reported on IRS Form 8825 for partnerships and S-corporations are to be treated as self-employment income, regardless of whether or not the Borrower is personally obligated on the Note and regardless of the Borrower’s percentage of ownership interest in the partnership or S-corporation. The requirements of Section 5401.2(c)(v) are not applicable. Refer to Form 91 for the appropriate treatment and calculation of the Borrower’s proportionate share of the net rental real estate income or loss.

(k) Self-employment income not used for qualification The following table contains requirements and guidance pertaining to self-employment income not used for qualification: Self-employment income not used for qualification Topic Requirements and guidance Self-employment disclosed on Form 65 (or other documentation) but not used to qualify The Seller is not required to obtain any additional documentation or evaluate the income or loss from the selfemployment for each Borrower on the Mortgage who: ■ Has a primary source of income, other than selfemployment, used for qualifying for the Mortgage (e.g., salaried income from primary employment), and ■ Is self-employed and self-employment income is a secondary source of income For each Borrower on the Mortgage who is self-employed and does not have another source of income that is used in qualifying for the Mortgage, the following requirements apply: ■ The Seller must obtain pages 1 and 2 of the Borrower’s federal individual income tax returns, and the applicable schedules (e.g., Schedule C, Schedule E), to determine if there is a business loss that may have an impact on the stable monthly income. Refer to Section 5302.4(b) for information about using IRS tax transcripts to meet certain portions of this requirement. • If a business loss is reported and the Borrower qualifies with the loss, then the Seller is not required to obtain any additional documentation relating to the business loss • If a business loss is reported and the Borrower does not qualify with the loss, then the Seller must perform a business and income analysis to determine whether depreciation adjustments or other factors such as business closure or evidence of a one-time non-recurring event justify a reduction of the reported loss when calculating the stable monthly income. The Seller must obtain additional documentation needed in order to fully evaluate the loss and support the analysis (e.g., business tax returns (final or otherwise), evidence of a one-time non-recurring event). ■ If the tax returns or other documentation in the Mortgage file (e.g., IRS tax transcripts, additional Schedule K-1’s) reflect positive income from self-employment but that Self-employment income not used for qualification Topic Requirements and guidance income is not used to qualify, additional documentation (e.g., complete business or federal individual income tax return(s)) is not required

(l) Business assets used for closing The following table contains requirements and guidance pertaining to business assets used for closing: Business assets used for closing Subject Requirements and guidance Business assets used for closing ■ Withdrawals of assets from the business may have a negative impact on the ability of the business to continue operating. When business assets are being used for the Down Payment, Closing Costs and/or reserves, the Seller must determine that the withdrawal of the funds will not have a detrimental effect on the business. In addition to a review and analysis of the personal and business tax returns, the Seller may review and analyze the current financial statement and/or the last three months of the business bank statements to confirm the deposits, withdrawals and balances are supportive of a viable business and are aligned with the level and type of income and expenses reported on the business tax returns. ■ The factors contributing to the determination that the withdrawal will not negatively impact the business must be included on the Seller’s written analysis of the income source and amount The business assets must be verified in accordance with the documentation requirements in Sections 5102.3, 5102.4 and 5501.3. (m)Verification of current existence of the business The following table contains requirements and guidance pertaining to verification of current existence of the business: Verification of current existence of the business Topic Requirements and guidance Verification of current existence of business Verification of the current existence of the business is required when positive income from the business is used as stable monthly income. Acceptable third-party sources Acceptable third-party sources include, but are not limited to: ■ Regulatory agency ■ Phone directory ■ Internet source (e.g., Better Business Bureau) ■ Directory assistance ■ Applicable licensing bureau Verification of current existence of the business obtained verbally from an acceptable third-party source must be documented and include all of the following: ■ Name and address of the business ■ Name of individual and entity contacted to obtain the verification ■ Date information verified ■ Name and title of the individual who completed the verification for the Seller Alternative sources The Seller may consider alternative sources if the above are not available, such as: ■ Preparer of the tax returns for the business (e.g., accountant), provided the preparer has an arm’s length relationship with the Borrower ■ At least one months’ business bank statement that supports the current existence of the business and the level and type of income and expenses reported on the business tax returns Date requirements The verification must be completed prior to the Delivery Date, but no more than 120 days prior to the Note Date. (n) Documentation requirements The Seller must establish and calculate the stable monthly income using at least the following required documentation. Additional documentation may be needed to support income stability, as described within this chapter. ■ Form 91 or a similar alternative form (e.g., Income Calculation Report or Freddie Mac Income Calculator Certificate, both as described in Section 5304.2) ■ Verification of the current existence of the business as described in Section 5304.1(m) ■ Federal income tax returns, as required in the table below, including all applicable schedules and forms must reflect at least 12 months of self-employed income ■ Verification of how long the business has been in existence: • For partnerships, S-corporations and corporations, the federal income tax return(s) for the business must indicate the number of years that the business has been in existence • For sole proprietorships, the federal individual income tax return(s) and any other documentation or information received must not contradict the number of years that the business has been in existence as documented on Form 65 Business structure Streamlined Accept and Standard Documentation levels Business in existence greater than or equal to five years1 Business in existence less than five years Sole proprietorship Complete signed federal individual (Form 1040) income tax return for the most recent year Complete signed federal individual (Form 1040) income tax returns for the most recent two years Partnership Complete signed federal individual and partnership (Form 1065) income tax returns, including the Schedule K-1(s) for the most recent year Complete signed federal individual and partnership (Form 1065) income tax returns, including the Schedule K-1(s) for the most recent two years S-corporation Complete signed federal individual and S-corporation (Form 1120S) income tax returns, including the Schedule K-1(s), Form 1125-E and W-2(s) if applicable, for the most recent year Complete signed federal individual and S-corporation (Form 1120S) income tax returns, including the Schedule K-1(s), Form 1125-E and W2(s) if applicable, for the most recent two years Corporation Complete signed federal individual and corporation (Form 1120) income tax returns, including Form 1125-E and W2(s) as applicable, for the most recent year Complete signed federal individual and corporation (Form 1120) income tax returns, including Form 1125E and W-2(s) as applicable, for the most recent two years 1 The Borrower must be self-employed (i.e., have an ownership interest of 25% or more) in the same business for at least five years