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Michael asks:

I have a self employed borrower who paid alimony with company funds. Expenses paid through the business would normally not count against his debt-to-income ratio as a debt.

We’ve confirmed with the CPA, however, that the alimony will continue to be reflected on line 31A of the 1040, not on the Schedule C as an expense. The amount reported on line 12 from Schedule C will not include any alimony expense and the amount listed on line 31A will be an adjustment to the total earnings.

Does the source of funds used to pay alimony (personal or business) make a difference on how the tax return is completed? How should we treat this alimony?

Linda says:

Wouldn’t it be great if we could just hide things we do not want to count against us personally by paying it from our business? But alas, we cannot. Neither the IRS nor (it appears) FannieMae care about which account pays for things when it comes to Schedule C filers. Nor should they.

The source of the alimony payment

Your borrower certainly could take a withdrawal from the business checking account, deposit that amount into their personal account, and then write a personal check to cover the alimony.

But the tax preparer properly categorized those business checks as a personal use, and therefore put the expense where it belongs on the alimony paid line of the 1040.

Another (in my opinion, better) option

If you were not doing a secondary market mortgage loan, some banks will subtract alimony from income rather than putting it on a debt list. That is my preference as well, since it more accurately reflects the reality. Alimony, as well as child support, is an income shift between households. Many lenders subtract it from the borrower’s income and then determine if the remaining household cash flow meets the debt-to-income criteria for that borrower household debt.

If you ever have that option, Michael, take it. But if not, the alimony will have to be treated as if the Schedule C filer paid it from their personal account.

Car expense and travel … same issue?

Have you ever had a borrower say “my business pays for my cars” as if that means the car debt payments should not be counted against them personally? If I were not trying too hard to make the loan, or be nice, I might ask if they always walk to the grocery store or on other personal errands.

Payment by a business of expenses that are personal does not change their nature. And if the amounts are significant and the borrower clearly knows it is wrong, perhaps this is a red flag you do not want to miss.

You have probably heard the reverse when their business does not seem to be making enough money. They’ll try to get you to add back car and travel because it really IS personal.

Lenders and Tax Preparers Agree

The point is the same. On a 1040, an expense should be recorded based on what it was, not what bank account cut the check. And the lender should treat it accordingly.

More on 1040 Analysis

Alimony is one of the subjects covered in our module on 1040 Page One. Check it out at www.LendersOnlineTraining.com.

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.