1099 vs. W-2 for MLO comp - Which Won't Land You in Hot Water?

Few people grow up wanting to be an LO or a capital markets gal. But plenty grow up wanting to be astronauts. Ever wondered what an astronaut earns, and what the job description looks like? Here you go: MajorTom - thanks to Carol K. who sent that along and pointed out that "this is a drug-testing designated position." (Keeping with the space theme, Dr. Matt Lind suggests that Quicken Loans' employees are having a "blast" with the Rocket Loan.)

"Rob - what is the CFPB's stance on loan originator compensation and whether it can be via 1099 or W-2? Recently, I have noticed a surge in advertising by mortgage brokers promising to pay mortgage loan originators via 1099 instead of W-2, and some LOs leaving lenders to go to work for brokers believing they can be "1099'ed" (rather than W-2) allowing them to use Schedule C to write off quite a bit on their taxes. Their justification for doing this is that the originators are 'independent contractors' since they're working for a broker. But the determination of whether someone is truly an 'independent contractor' or an 'employee' ordinarily requires a detailed factual analysis and is determined on a case-by-case basis. There would be much more to the analysis than the mere fact that one is working for a broker. In 2006, HUD issued a 'Mortgagee Letter 2006-30' which requires that all employees' compensation be reported on form W-2. But they provide little practical guidance on when said 'employees' must be utilized and under what circumstances (if any) independent contractors can be utilized."

The note went on. "Since this Mortgage Letter was published there have been many changes in our industry. As a result, we have received conflicting information on this topic from numerous sources, including the CFPB. Therefore, the question many of us would like answered is, 'Can we even consider hiring originators as contractors? Is the Mortgagee Letter from 2006 still a valid tool for those of us seeking guidance? If not, and without further rules/guidance from the CFPB, one can only suspect that we are to go back to square one (i.e. pay originators via 1099 only if they truly qualify as an independent contractor under applicable state law)."

Sam Gilford with the Consumer Financial Protection Bureau contributed that from the CFPB's perspective, "Loan originator compensation must comply with the requirements in 12 CFR 1026.36(d) and (e). Those constraints govern how compensation may be determined but not how the services of a loan originator on behalf of a creditor may be structured. The individual you were corresponding with may wish to contact HUD directly regarding the current status of the Department's referenced 2006-30 Mortgagee letter, as the Bureau cannot speak on behalf of HUD."

As always it is best to consult your attorney on potential gray areas/issues such as this, but the CFPB is deferring to the HUD Rule regarding compensation for Mortgage Brokers and Mortgage Bankers in determining whether Loan Officers are to be paid via 1099 or W-2. One can always take a look at the FAQ from HUD, page 4, where it discusses compensation.

One veteran mortgage banker wrote to me saying, "The mortgagee letter from 2006 may be a little dated, and some are of the opinion that today the brokers can compensate via a 1099. I don't necessarily like it, but it is what it is. I am more concerned that we as a mortgage banker, as a HUD approved lender, have to do an annual certification that states our loans, to the best of our knowledge, meet HUD guidelines. Do brokers paying their MLOs on 1099s on FHA insured loans do that?" And a banker wrote saying, "I wouldn't touch a 1099 LO setup with a 10 foot pole. With all of the scrutiny on LO comp I surprised someone is attempting to do this."

The CFPB refers to Mortgagee Letter 2006-30 and affirms it will follow HUD's rule, which is to say that Mortgage Brokers and Mortgage lenders must pay their loan officers W-2 and that 1099 is illegal under HUD/CFPB Guidelines. Some may question whether it is permissible to allow their LOs to be simultaneously classified as both an independent contractor (1099) and an employee (W-2). The short answer is: not likely. Indeed, though it is "possible" in some circumstances to work as both an employee and an independent contractor, if the worker's services are interrelated, then the worker cannot be considered to be acting in two different capacities. In other words, the two jobs performed by the loan officer must be separate and distinct in order to be properly issued a W-2 and a 1099 from the same employer. Folks who are "in the know" about such matters usually point to IRS documents and court cases such as Rev. Rul. 58-505, 1958-2 C.B. 728; Reece v. Commissioner, 63 T.C.M. (CCH) 3192 (1992); IRS Training Manuals, Training 3320-102 (Rev. 10/96).

Mike Barone with the Lenders Compliance Group scribes, on the question of, "Can loan originators be treated as independent contractors (1099) or must they be treated and paid as employees (W-2)?" FHA lenders have been long required to report all of its employee's compensation on Form W-2 (See Mortgagee Letter 2006-30).  This requirement has been carried over into the new FHA Handbook [see Handbook FAQ Page 7 or 4000.1:I.A.3.c.iv.(B)(3)(b)(ii)].  Moreover, the new FHA Handbook specifically lists those functions that can be contracted out; clerical assistance, processing, ministerial tasks in servicing, legal and QC [See Handbook 4000.1:I.A.6.j.(i)]. 

"With regard to brokers acting as a Sponsored Third-Party Originator (TPO), Mortgagee Letter 2012-2 stated that FHA lenders were responsible for ensuring that each TPO they sponsor adhered to FHA's requirements. This language was not carried over to the new FHA Handbook.  As a result, many brokers have been trying to recruit loan originators with a promise that they will be treated and paid as an independent contractor. Not so fast.

"According to the IRS, one is not an independent contractor if he/she performs services that can be controlled by an employer (what will be done and how it will be done). What matters is that the employer has the legal right to control the details of how the services are performed. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. Can any employer (whether lender or broker) defend the position that a loan originator is an independent contractor (and therefore does not control what or how the loan originator performs his/her duties) when the employer as well as examiners mandate that they must follow company policies and procedures, including but not limited to company oversight of safeguarding private information? Conventional wisdom, as well as many judicial decisions, says no."

Mike's note continued. "There are many states that have statutes which refer to paying LOs as independent contractors (1099's). NY specifically allows it in Part 38. Nevertheless, I do not see how the job responsibilities of a loan originator fit within the definition of an independent contractor as set forth by the IRS, and regulators are always concerned with any potential violations of law and not just those that are compliance violations."

But pointing out the conflicting regulations from the U.S. Government, another veteran compliance person relied on the commentary to Reg. Z §1026.36(d)(3)(v) saying they think Reg. Z at least assumes that paying LOs on a 1099 basis is happening: "For purposes of § 1026.36(d)(1)(iv)(B)(1), the individual loan originator's total compensation consists of the sum total of: (1) all wages and tips reportable for Medicare tax purposes in box 5 on IRS form W-2 (or, if the individual loan originator is an independent contractor, reportable compensation on IRS form 1099-MISC) that are actually paid during the relevant time period...If an individual loan originator has some compensation that is reportable on the W-2 and some that is reportable on the 1099-MISC, the total compensation is the sum total of what is reportable on each of the two forms."

Turning to interest rates, although they don't have crystal balls (as in fortune telling!), lots of experienced capital markets folks went into the Fed's short-term rate increase thinking little would happen to long-term rates - like 15 & 30-year mortgage rates. Sure enough, yesterday the U.S. Treasury market improved Thursday. The economic news was mixed, with the manufacturing sector showing continuing weakness (as measured by the Philly Fed) but Leading Indicators beating estimates on the contribution from building permits. Initial and continuing jobless claims came out roughly in line with estimates.

It is a "Friday heading two weeks of holiday trading" today with no economic news and men everywhere thinking they should leave work early to find something nice for their gals. In terms of rate sheets we closed the 10-year at 2.24% Thursday and this morning we're at 2.22% with agency MBS prices a smidge better. It is not hard to imagine us still being around these levels two weeks from now.

It is the holidays, and I receive my fair share of automatic e-mail responses. Some are actually apologetic about taking a day off, or even leaving work for the day. And every once in a while someone breaks out of the mold. (Part 5 of 5 where I took the time to some of the more interesting ones.)

Jobs and Announcements

In lending news, word spread that iServe Real Estate Operations, Inc. reached the milestone of selling and servicing over 25,000 REO assets with a value of approximately $1.9 Billion. iServe Real Estate Operations, Inc., a nationally recognized asset manager that offers full service default services, announced that it was able to do this through the use of its proprietary technology systems and expertise in managing challenging assets. "iServe REO ensures each asset is managed with a high-touch approach by a seasoned team. The iServe advantage is founded on three cultural principles: proactive risk management, collaborative solutions and targeted results. The combination of these principles has led iServe REO to be awarded Asset Management Company of the year for 2012 and 2013 for a large "Money Center Bank." Among many other accomplishments, iServe REO has been successful in managing over 5,000 HOA assets for incremental savings of approximately $1M, resolving over 1,300 code violations for additional savings of $1.5M, correcting 12,000 title issues for a savings of over $2.3M and processing over 800 Cash for Keys for clients.

With lenders grappling with loans that won't be purchased due to TILA-RESPA reform, I received this note. "Stuck with loans you can't sell because your investors have interpreted them to be in violation of TRID? Right House Capital can help! As a buyer and broker of 'Scratch and Dent' loans, RHC has contacts nationwide that will purchase loans in violation of TRID. If the only flaw on the loan is a TRID-related and is still agency-eligible, Right House has the ability to put those into a FHLMC, FNMA, or GNMA security and obtain optimum pricing.  If the loan isn't eligible for agency delivery, Right House has many other contacts that will pay the best price the market will bear."  For more information, contact Director of Sales Craig Beard (727.498.0292).

And I received this note from Scott Alexander, Operations Manager at Assurance Financial in Baton Rouge. "We continue to hear horror stories with other lenders having system-related TRID issues resulting in loans being ineligible for sale. But we have not had one loan rejected for purchase because of a TRID defect relating to an operating system error. In fact, we have not had one closed loan deemed ineligible for purchase. Assurance Financial realized early on that the changes mandated with TRID would require team member training and loan origination system enhancements. We dedicated a tremendous amount of time and money towards making sure our loan origination system was prepared for the upcoming TRID changes. We also made sure our operations and sales teams were prepared for the changes by conducting many training sessions including training sessions to educate real estate agents in our retail markets." The local Realtor associations were very appreciative of Assurance's training sessions. Assurance Financial continues to meet closing deadlines while complying with TRID."