The S-Corp Owner Who Lost Her Biggest Account
Dana is a 51% owner and officer of a two-person S-corporation doing commercial landscaping. Her application states $11,200 per month of self-employment income. The file contains 2023 Form 1120-S showing ordinary business income of $42,000 (her K-1 share is $42,000) with depreciation of $7,200, and 2024 Form 1120-S showing ordinary business income of $54,000 with depreciation of $9,000. Her W-2 wages from the corporation were $68,000 in 2023 and $72,000 in 2024. She took $20,000 of cash distributions in 2024. A year-to-date profit-and-loss statement shows 2025 ordinary income running about 18% below the same period in 2024; her CPA attributes it to losing one large account in March, with no replacement contract signed. Proposed PITI is $3,900. Debts: $620 auto loan, a $540 auto loan she cosigned for her son, and a $95 student loan payment. Credit score 742.
1. Calculate Dana's qualifying monthly income on a two-year averaging approach. Identify each add-back and each exclusion, and explain why the $20,000 of distributions is treated the way you treat it.
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Step 1 - Business income with add-backs
| Year | K-1 ordinary income | + Depreciation | Qualifying |
|---|---|---|---|
| 2023 | $42,000 | $7,200 | $49,200 |
| 2024 | $54,000 | $9,000 | $63,000 |
Two-year average: ($49,200 + $63,000) / 2 = $56,100 per year, or $4,675 per month.
Depreciation is a non-cash deduction, so it is added back. No other add-backs are supported by the file.
Step 2 - W-2 wages
($68,000 + $72,000) / 2 = $70,000 per year, or $5,833 per month. This is not double counting: the corporation deducted the wages before arriving at ordinary business income, and Dana has already paid personal tax on them.
Step 3 - Distributions
The $20,000 is excluded. An S-corp distribution is a draw against profit that has already been counted through the K-1; adding it would count the same dollars twice and inflate qualifying income.
Step 4 - Total
$56,100 + $70,000 = $126,100 per year = $10,508 per month. Note this is $692 below the $11,200 stated on the application, so the income used for underwriting must be the documented figure, not the stated one.
2. Using the averaged income, compute total debt-to-income. Then explain what must be documented to leave the cosigned auto loan out of the calculation, and what the DTI becomes if it is excluded.
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Including all debts:
- PITI $3,900 + auto $620 + cosigned auto $540 + student loan $95 = $5,155
- $5,155 / $10,508 = 49.1%
That is inside the 50% ceiling commonly applied to an automated underwriting recommendation, but with almost no cushion.
Excluding the cosigned loan: a cosigned obligation may be omitted only when the file shows the other party has been making the payments for the last 12 months - typically 12 months of canceled checks or bank statements from the son's account, plus evidence he is obligated on the note. A borrower's verbal statement that 'he pays it' is not documentation.
- $3,900 + $620 + $95 = $4,615
- $4,615 / $10,508 = 43.9%
The 5-point swing is worth pursuing, but only with the documentation in file.
3. The 2025 year-to-date profit-and-loss shows an 18% decline attributed to losing a major account, with nothing lined up to replace it. How should this affect the income used, and what is wrong with simply keeping the two-year average?
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A two-year average is not automatic. Averaging is appropriate when the decline is shown to be a one-time or non-recurring event. Here the cause is the permanent loss of a large customer, and the CPA confirms there is no replacement revenue - a continuing condition, not an anomaly.
A defensible approach under this fact pattern:
- Annualize the YTD business income: $54,000 x 0.82 = $44,280, plus $9,000 depreciation = $53,280 per year ($4,440 per month).
- Combine with W-2 wages of $70,000: $123,280 per year = $10,273 per month.
- Recompute: $5,155 / $10,273 = 50.2%, which now fails the 50% guideline even before the cosigned-loan issue is resolved.
What the MLO should do, in order: obtain a written explanation of the declining income, the CPA-prepared YTD P&L and the corporate/business returns, and a year-to-date balance sheet; document the analysis; and let underwriting decide whether to use the average, the YTD figure, or a lower figure. Do not present only the most favorable number, and do not 'shop' the file by re-running findings until an approval appears.
If the cosigned loan is properly excluded, the DTI under the YTD approach is $4,615 / $10,273 = 44.9%, which changes the picture materially - so both the income and the debt analysis have to be settled on documentation, not on which combination produces an approval.