What This Guide Covers
- The 25% commission threshold that triggers self-employment treatment
- How unreimbursed business expenses reduce your qualifying income
- W-2 vs 1099 commission: two completely different documentation paths
- Averaging rules and what happens when your commission income changes year over year
How Underwriters Calculate Commission Income
Commission income is calculated using a two-year average from your federal tax returns, not your paystubs. The underwriter uses Schedule A (for unreimbursed employee business expenses, via Form 2106) and your W-2s or 1099s to arrive at a net qualifying income figure.
The threshold that determines your underwriting path is whether commission income represents 25% or more of your total annual income. If commission exceeds 25%, Fannie Mae treats you as a commissioned borrower and requires the two-year return analysis including expense deductions. If commission is under 25% of total income, it is treated as regular W-2 income with a simpler documentation path.
For W-2 commissioned borrowers, the analysis pulls the commission amount from Box 1 of the W-2, then deducts any unreimbursed business expenses claimed on Form 2106, which flows through Schedule A. The net figure is what qualifies.
For 1099 commissioned borrowers, the income flows through Schedule C as self-employment, and full self-employment income analysis applies including add-backs for depreciation and deductions for business expenses.
Required Documentation
- ✓Two years of federal tax returns (all pages and schedules)
- ✓Two years of W-2s or 1099s showing commission income
- ✓YTD paystub showing year-to-date earnings including commission breakdown
- ✓Form 2106 for unreimbursed employee business expenses (if applicable)
- ✓Employer letter confirming commission structure and likelihood to continue (if income is declining)
- ✓Schedule C and business bank statements if income is 1099-based
What Most Lenders Get Wrong
- 1.Using paystub commission figures rather than the two-year tax return average. Paystubs show what was paid; returns show what was earned after deductions. The underwriter must use the lower of the two figures or the return average.
- 2.Ignoring Form 2106 unreimbursed business expenses. A commissioned sales professional who drives 30,000 miles per year and deducts mileage on Form 2106 has less qualifying income than their gross commission suggests. Skipping the 2106 analysis overstates qualifying income.
- 3.Using the higher-earning year when income declined in the most recent year. Fannie Mae requires the lower of the two-year average or the most recent year when income is trending down.
- 4.Misapplying the 25% threshold by using gross income instead of total income on the tax return, which can push a borrower into or out of commissioned income treatment incorrectly.
Declining Commission Income: The Rule That Costs Borrowers the Most
The most consequential rule in commission income underwriting is what happens when year-over-year income declines. Fannie Mae is explicit: if commission income decreased from year one to year two, the underwriter must use the most recent year's income, not the two-year average.
This is devastating for borrowers who had an unusually strong year two years ago and a normal year most recently. A salesperson who earned $120,000 two years ago and $85,000 last year qualifies at $85,000, not at the $102,500 average. The higher year is effectively ignored.
The exception is when the lender can document a specific, non-recurring reason for the decline, such as a medical leave, a company restructuring, or a temporary market downturn in the borrower's industry. In those cases, some lenders and some underwriters will accept an explanation letter alongside current-year YTD figures showing recovery. This is a judgment call at the underwriting level and not a guaranteed outcome.
For borrowers with declining commission income, the strategy is often to wait until the most recent year's income has stabilized or increased before applying, or to apply in the early part of the year when YTD figures can be used to show a recovery trend.
The 2106 Trap: How Expense Deductions Shrink Your Qualifying Income
Form 2106 (Employee Business Expenses) is used by commissioned employees who are not reimbursed for work-related costs, including mileage, client entertainment, home office expenses, and equipment. These deductions reduce taxable income, which is their purpose, but they also reduce mortgage qualifying income by the same amount.
A real estate agent earning $90,000 in gross commissions who deducts $15,000 in unreimbursed expenses on Form 2106 qualifies at $75,000 annually, or $6,250 per month, not $7,500. The deduction is real and the underwriter must account for it.
Since the Tax Cuts and Jobs Act of 2017, the deduction for unreimbursed employee business expenses on Schedule A was eliminated for federal income tax purposes for most employees. This actually helps commissioned borrowers because the 2106 expense deduction no longer reduces qualifying income for loans originated after that period. However, self-employed commissioned borrowers on Schedule C still deduct business expenses, and those deductions still reduce qualifying income the same way they always have.
For W-2 commissioned borrowers who file after 2017 and are not deducting 2106 expenses (because the federal deduction no longer exists), the qualifying income analysis is simpler: the gross commission from the W-2 averaged over two years is used directly.
Commission income files are won or lost on the return analysis. I have had underwriters try to use the wrong year, miss expense deductions, and misapply the 25% threshold. The borrower does not see any of this happening. What they see is a delay or a decline. My job is to do the analysis correctly upfront, present it clearly to underwriting, and prevent the back-and-forth that kills timelines.
Do you have commission income and want to know where you stand?
Call Dan at (661) 342-9381. He will review your specific situation and documentation in a free call.