Requesting transcripts of your tax returns was a common policy for self-employed borrowers before the housing crisis. Today, however, lenders almost always request a transcript to verify your taxes, whether you are self-employed or not.
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Why Lenders Request Transcripts of your Tax Returns
Requesting the transcripts of your tax returns helps lenders verify the information you provided them. It shows that the returns you provided were not altered in any way. In other words, the information you gave the lender is exactly what you gave the IRS.
What is a Tax Transcript?
The tax transcript is not an identical print of your tax returns. Instead, it’s a line item document that shows the same (hopefully) numbers you provided on your tax return. The transcripts do not contain all of the schedules you have on your tax returns, but it will provide the numbers on those schedules. This is what the lender needs.
How Lenders Get Your Tax Transcript
In order for the lender to order your tax transcript, you must sign Form 4506-T. This allows the lender access to your tax transcript. They send the signed document to the IRS who then sends the lender your tax returns within a few weeks. It’s customary to sign the transcript form right away after accepting a lender’s offer so the transcript does not hold up your loan’s processing.
Why Tax Returns Matter
You might wonder why a lender even needs your tax returns. Isn’t paystubs or a P&L from your business enough? Tax returns just provide lenders with more proof of your income. It shows that what you say you claimed on your taxes is truly what you claimed. However, there’s another reason.
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Lenders often request tax returns from borrowers that own their own business or work on commission. These borrowers often claim many expenses on their taxes. These expenses take away from their gross income. The lender can only use the net income you claim on your taxes. So your tax return income may not match the income on your paystubs or P&L. The lender can only use the income on your taxes, though, which may hurt you.
As far as a layer of protection, though, the lender matches the tax returns with your other proof of income. If there is some type of inaccuracy, the lender will start investing the reason. They may come directly to you for an explanation or they may do some verifying on their own. It could greatly delay the underwriting process, so it pays to make sure everything matches before applying for a loan.
If you own your own business, the lender will need to verify that there isn’t a business loss that you tried hiding with your income documents. This is why they use the net income from your tax returns, rather than the documents you provide. If there is a net loss, the lender must use this for qualifying purposes, which could harm your chances of approval. They do add back certain expenses, though, such as depreciation.
One last reason lenders care about your tax returns is to see if you owe the IRS money. This isn’t a deal breaker if you do; however, there are rules. If you owe money, you either have to pay it in full or have a payment arrangement set up. If you have the payment arrangement, you’ll also have to prove that you make your payments on time. There isn’t a specific amount of time you must have the arrangement, but the longer history you can show, the better off you’ll be.
Your tax returns play an important role in your ability to secure a loan. Make sure you provide the ‘real’ returns along with a signed 4506T so that the lender can get the process rolling right away.