I was chatting with someone the other day, who asked a hypothetical question.
Let’s say “Tom” wants to borrow money to buy a house. Tom’s only source of income is his full-time job. The bank is willing to lend, let’s say, $250,000 for Tom to buy his house, based on his annual earnings.
However, the house Tom wants to buy is $300,000. So, could Tom, legally (not ethically, but could he legally, do the following):
Tom has $25,000 in savings. He hands this money over to his dad as a gift. Tom’s dad, a business owner, employs Tom as a… let’s say… “advisor”. Whether Tom actually ever gets called upon to advise is irrelevant, but perhaps Tom has the occasional chat with his dad about how the business is going.
Tom’s dad simply pays Tom, in wages, up to the amount of $25,000, so Tom’s dad is not out of pocket.
Tom turns up to the bank, declares his new income, and away he goes, bank loan secured.
Why doesn’t the bank count his savings as part of his assets? The 25K would be part of the down payment, for example, bringing the loan amount to 275K?
As to the legality of the actual situation, I cannot say.
I would say it’s less a question of ‘legal’, and more a case of bank underwriting policy. The only ‘legal’ question would be if Tom was accused of fraud and/or misrepresentation on his application and had to defend his practice.
This would probably be more of an issue with a major national lender who sets up inflexible policy to deal with millions of applications across the USA, and doesn’t use judgemental underwriting (meaning, an actual human looks over the documents and makes a judgement call about certain ‘grey areas’). And Tom wants to ‘go around’ that policy using the little trick above.
But for a local lender who employs judgemental underwriting, the underwriter would probably look at all of that documentation anyway and dig through to find the source of the $25,000. And they may not even care. The trick may be unnecessary.
In most cases, if he’s using the $25K as an asset to qualify for the loan (a reserve), he’ll have to sign something at closing that says he’s still got the cash, and he might even have to produce a bank statement. Failing to disclose the withdrawal would be fraud.
It depends what you told the lender. No law prohibits you from giving your father money to pay you wages. Of course, you won’t get the whole $25K back–taxes will have to come out.
But you’ve essentially created some sort of a term employment situation. When the $25K runs out, you’re out of a job. Various underwriting rules (depending on the kind of mortgage you apply for) will require the lender to ask you some questions that might or might not tease out what’s really going on. In some cases, the income won’t be counted because you haven’t had the second “job” long enough. Underwriters also tend to scrutinize family employment deals more carefully because you aren’t the first person to come up with the idea of faking a job with a family business in order to inflate his income. If you falsify information in order to bolster your fake “job” claim, you’ve committed loan fraud.
Gift tax isn’t “taken out.” You’ve got to file a return and pay it. Whether you’d owe gift tax depends on how much you’ve gifted in the past to some extent because of the unified credit and would also depend on whether Tom is married because of gift splitting and the annual exclusion. Also, depending on the timing, Tom could split the gift between tax years. See generally http://www.irs.gov/pub/irs-pdf/p950.pdf
Everytime anyone buys a house, there’s a form called a HUD-1 that has to be drawn up and filed with the government. It basically shows where all the money is coming from and where it is going to. The IRS will certainly get wind of the $25K income and want their cut of it.
I was going to make the point about a gift tax applying to the $25k as well, plus when Tom’s dad pays it back to him as salary he’ll have income tax there. I think that $25k would be reduced by half by the time it makes this round trip.
As to the questions of fraud, if Tom is up front with his lender and tells them all these details, it can’t be fraud. So the answer is: yes, it’s legal, given that the lender is aware of what Tom is doing.
If you think that telling the lender defeats the whole point, then that tells me that what you’ve dreamed up here is indeed fraud.
The bank most likely won’t use his new $25k in income towards the loan approval. It’s not going to be shown on his last tax filing so it can’t be proven as recurring income, it would be considered as a one time payment, like a bonus. It’s not going to help him any unless he can pull this off for a few years, and pay income tax on it as well.
I’m lost. If he has a full time job with income, why does he have to prove that he’s getting income from the “gifted” (taxed (limit is $13,000 for 2009) money from his dad?
It seems to me that if enough people were to trick the system with their own scams similar to the one described by the OP, the overall economy would probably suffer to the detriment of all, including those who are scamming the system in order to get something for nothing. We might even end up in a major economic crisis in several years time.
Notice the form requires additional information if you’ve been employed less than two years. For a while, you may recall, lenders offered stated income and no-doc loans, which basically permitted them to take the information on the 1003 as true. Those loans are no longer available. A lender will ask for documentation of your income (may include previous tax returns, W-2s, pay stubs, and a letter from your employer), verification of employment, and might look into the background of your employer. Of course, if you’d asked this question a few years ago, the answer would have been: If you apply for a stated income loan, they’ll take your word about how much you make. But lying about your income is still illegal. See the acknowledgement on Form 1003.
While Gfactor has dealt with the issue of a possible gift tax, wouldn’t there be tax when the money comes back the other way?
If, per the OP, Tom’s dad takes the money Tom gifted him, and uses it to hire Tom as an adviser (or whatever), then the money he pays Tom for being an adviser would surely be subject to income tax, would it not?
ETA: Of course, now i notice that a couple of other people have made a similar point.
Yes. As you note, it’s been addressed upthread, but he’d probably have to demonstrate through W-2s or paystubs that taxes were withheld if he was claiming that it was income generated from employment. Not paying the taxes actually makes the whole plan pretty worthless. If he’s claiming it as some sort of consulting “fee” as an independent contractor, it’s even less useful for getting the loan.
Also, HUD-1s are not “filed with the government.” They are disclosure forms for the consumer. Government agencies do review them for compliance with state and federal lending laws:
If the loan is insured as part of a government program (VA, USDA, FHA);
As part of an audit of a mortgage broker or lender.
But the information wouldn’t ordinarily go to the IRS.
Heck. Why all the subterfuge? Have Tom’s dad only say that he pays him a salary, and that’s the end of it. Tom can use the $25,000 to pay income taxes on the salary that he’s not really receiving.