IRS Form 4506-C and tax return transcripts: Not just for self-employed borrowers
The IRS Income Verification Express Service (IVES) Request for Transcript of Tax Return (IRS Form 4506-C) plays a crucial role when selling loans to the secondary market. In addition to being a requirement of the post-closing quality control (QC) procedures, tax transcripts are an effective tool to evaluate your borrower’s ability to make loan payments and a valuable means to detect and prevent fraud.
Form 4506-C is used to allow the borrower to give the lender permission to request the borrower’s tax transcripts directly from the IRS. While it is a best practice to obtain tax transcripts on all loans at origination, tax transcripts are generally not required for underwriting standard W-2 income borrowers.
Transcript exceptions
Conversely, for most loans selected for QC review, there is a requirement to obtain tax transcripts. Exceptions to the QC requirement vary by investor. Common examples include loans that have gone through Fannie Mae’s Day 1 Certainty program or Freddie Mac’s LoanBeam software, where all income information was verified using an approved and cleared vendor or if the tax transcripts were obtained as part of the underwriting process (tax transcripts in the file for underwriting may be used for the QC review).
Get the details right
It is important that all information on Form 4506-C is reviewed for accuracy to avoid getting a rejection notice. Common causes for rejection notices from the IRS include missing signatures, boxes unchecked, tax years not completed, incorrect name, incorrect Social Security number or incorrect address (including using abbreviations when the tax return does not have one). Below are some helpful reminders to consider when completing Form 4506-C:
- Only one tax form type (for example 1040, 1120, 1065, etc.) can be requested with each Form 4506-C.
- A self-employed borrower whose income documentation includes individual and business returns may need to complete two Form 4506-Cs.
- Requests for business tax transcripts, Forms 1120, 1120-S or 1065 require the form to be completed in the name of the company and include the title of the signer.
- Confirm that the years listed on the forms correspond to the most recent return(s) filed. For example, if you are taking an application in January 2021, request the 2018 and 2019 tax returns, since 2020 will not have been filed yet.
- Confirm that the previous address listed on the Form 4506-C agrees with the address on the most recent return filed. It may not always be their most recent address.
QC implications
From a QC perspective, we have seen a rise in errors related to Form 4506-C and the corresponding transcripts obtained (or not obtained). Again, it is important for origination staff to verify the accuracy of the information on the document. Form 4506-C is good for 120 days, which means a copy should be obtained at closing, QC samples selected in a timely manner and the transcripts requested at the time of sampling.
Except in cases of Rejection Code 10, possible identity theft or fraud, a rejected request for tax transcripts does not absolve the lender from the requirement to obtain the transcripts. Code 10 itself is a red flag that should alert the lender to perform some due diligence in confirming the borrower’s identity.
While obtaining a corrected Form 4506-C during the underwriting process can be as easy as having the borrower(s) sign a new form, obtaining a new 4506-C for QC can be much more difficult, if not impossible. Tracking down a borrower for a signature and getting them to comply with your request is not always an easy task. The inability to obtain transcripts required for QC is viewed as a finding by the investors.
Another issue related to post-closing requests for tax transcripts is when the request comes back with no record of a return filed. Exceptions to the requirement of having to file taxes annually include, for example, a retired borrower earning only Social Security income who may not be required to file a tax return; however, depending on the type of income used to qualify for the loan, a record indicating no tax return was filed could be a big red flag. Lenders should have procedures in place to investigate these scenarios for signs of potential fraud.
Finally, and probably the most obvious, if the income amounts on the loan file documents do not agree with those of the transcripts obtained using Form 4506-C, the lender needs to do more investigation to determine the reason for any variances and whether it influences the amounts used for qualifying.
As always, you will want to review the Selling Guide(s) to determine the exact circumstances requiring the use of Form 4506-C, but it is an important document for all lenders to be aware of. It can also prove valuable in validating information used for qualifying your borrowers and avoiding quality control violations.
How Wipfli can help
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