source:
  type: guide
  id: fnma-sel-b3-3.7-02
  authority: Fannie Mae Selling Guide B3-3.7-02 — Analyzing Returns for an S Corporation
  description: Fannie Mae Selling Guide B3-3.7-02 — Analyzing Returns for an S Corporation.
  coverage_tier: operative
obligations:
- id: fnma-sel-b3-3.7-02-full
  canonical_id: fnma-sel-b3-3.7-02-full
  section: Fannie Mae Selling Guide B3-3.7-02 — Analyzing Returns for an S Corporation
  type: do
  tags:
  - regulator-direct
  - fnma
  - selling-guide
  - corpus-expansion
  - tier-operative
  primary_source:
    tier: 1
    authority: Fannie Mae Selling Guide B3-3.7-02 — Analyzing Returns for an S Corporation
    source_class: fnma-guide
    source_url: https://singlefamily.fanniemae.com/media/document/pdf/selling-guide
    snapshot_id: 5f7b8b79da595d76
    fetched_at: '2026-05-25T14:09:57Z'
    content_hash: sha256:98cf85a02861bbe84914a0e339b327c8fc131869a8a573882007bbeea60c5701
    paragraph_quote: 'B3-3.7-02, Analyzing Returns for an S Corporation (02/07/2024)
      Introduction This topic contains information on analyzing returns for an S corporation,
      including: Overview Evaluating the Business Income Borrower’s Proportionate
      Share of Income or Loss Adjustments to Business Cash Flow Overview S corporations
      and some LLCs pass gains and losses on to their shareholders, who are then taxed
      at the tax rates for individuals. S corporations and some LLCs use IRS Form
      1120S, Schedule K-1, for ﬁling federal income tax returns for the corporation.
      The shareholder’s share of income or loss is carried over to IRS Form 1040,
      Schedule E. See B3-3.5-02, Business Structures, for more information on S corporations.
      A borrower with an ownership interest in an S corporation or LLC may receive
      income in the form of wages or dividends in addition to their proportionate
      share of business income (or loss) reported on Schedule K-1. Evaluating the
      Business Income When the borrower has 25% or more ownership interest in the
      business, the lender must perform a business cash ﬂow analysis in order to evaluate
      the overall ﬁnancial position of the business and conﬁrm the business income
      is stable and consistent, and the sales and earnings trends are positive. If
      the business does not meet these standards, business income cannot be used to
      qualify the borrower. Borrower’s Proportionate Share of Income or Loss The borrower’s
      proportionate share of income or loss is based on the borrower’s (shareholder)
      percentage of stock ownership in the business for the tax year as shown on IRS
      Form 1120S, Schedule K-1. The cash ﬂow analysis should consider only the borrower’s
      proportionate share of the business income (or loss), taking into account any
      adjustments to the business income that are discussed below. Business income
      may only be used to qualify the borrower if the lender obtains documentation
      verifying that the income was actually distributed to the borrower consistent
      with the level of business income reﬂected on Schedule K-1, or the business
      has adequate liquidity to support the withdrawal of earnings. The lender may
      use discretion in selecting the method to conﬁrm that the business has adequate
      liquidity to Published May 6, 2026 385 support the withdrawal of earnings. When
      business tax returns are provided, for example, the lender may calculate a ratio
      using a generally accepted formula that measures business liquidity by deriving
      the proportion of current assets available to meet current liabilities. It is
      important that the lender select a business liquidity formula based on how the
      business operates. For example: The Quick Ratio (also known as the Acid Test
      Ratio) is appropriate for businesses that rely heavily on inventory to generate
      income. This test excludes inventory from current assets in calculating the
      proportion of current assets available to meet current liabilities. Quick Ratio
      = (current assets — inventory) ÷ current liabilities The Current Ratio (also
      known as the Working Capital Ratio) may be more appropriate for businesses not
      relying on inventory to generate income. Current Ratio = current assets ÷ current
      liabilities While a result of one or greater is generally suﬃcient to conﬁrm
      adequate business liquidity to support the withdrawal of earnings, lenders may
      support adequate liquidity using alternative methods with a documented rationale.
      Adjustments to Business Cash Flow Items that can be added back to the business
      cash ﬂow include depreciation, depletion, amortization, casualty losses, and
      other losses that are not consistent and recurring. The following items should
      be subtracted from the business cash ﬂow: travel and meals exclusion, other
      reported income that is not consistent and recurring, and the total amount of
      obligations on mortgages, notes, or bonds that are payable in less than one
      year. These adjustments are not required for lines of credit or if there is
      evidence that these obligations roll over regularly and/or the business has
      suﬃcient liquid assets to cover them. Recent Related Announcements The table
      below provides references to recently issued Announcements that are related
      to this topic. Announcements Issue Date Announcement SEL-2024-01 February 07,
      2024 Announcement SEL-2019-05 June 05, 2019 Published May 6, 2026 386'
  judgment: false
