Can a Loan Originator be paid by 1099 or must they be W2?
Can a loan originator be paid by 1099 or must they be W2?
Can a mortgage loan originator be considered an independent contractor?
Whether a loan originator can be paid by 1099 is truly a classic question for the ages in our industry. Especially in today’s world, where both independent mortgage bankers and brokers are experiencing margin compression, a common question I hear is whether a loan originator can be paid by 1099 or must they be W2?
Can a mortgage loan originator be considered an independent contractor?
Frankly, there is a tremendous amount of confusion on whether a mortgage loan originator (“MLOs”) can be treated as an independent contractor and thus receive payment via a 1099.
From the banker or broker’s standpoint, being able to pay their MLO via a form 1099 provides a significant payroll cost saving when compared to the additional tax burden that is experienced when paying as a W2 employee.
Thus, let us break down the issue step-by-step in order to provide further clarification to this longstanding argument on whether a mortgage loan originator can be paid by 1099.
I. State Laws
While there are a variety of states which permit an MLO to be paid by 1099, the mortgage banker or broker must still properly classify the MLO as determined by the IRS.
Regardless of state law, a failure to properly classify an individual as either an independent contractor or an employee, can lead to substantial ramifications as discussed hereinafter.
II. Federal Laws
While there is no specific overarching federal regulation that mandates all MLOs to be paid a W2, the following must be considered:
- Regulation Z – Loan Originator Compensation Requirements under the Truth in Lending Act
Proponents who argue that a loan originator can be paid by 1099 may assert that because the loan originator compensation rule includes both individual originators who are employees or independent contractors, the rule is designed to allow paying an MLO by 1099.
Paragraph 36(f)(2) states in part the following under License or registration Section 1026.36(f)(2):
“Thus, for example, a brokerage is responsible for verifying that the loan originator individuals who work directly for it are licensed and registered in accordance with applicable law, whether the individual loan originators are its employees or independent contractors who operate pursuant to a brokerage agreement.”
However, it is faulty to rely solely on this guidance to determine whether you can pay a mortgage loan originator by 1099 and treat them as an independent contractor. Remember, the mortgage banker or broker is still responsible for classifying the relationship as previously mentioned.
- Department of Housing and Urban Development (“HUD”)
Can an FHA-approved Mortgagee use non-employees as Loan Officers?
No. The Mortgagee may not use non-employees as loan officers.
Thankfully, HUD provides specific guidance on this issue which prohibits FHA-approved Mortgagees from using non-employees as loan originators, i.e., W2 employees may only originate loans for FHA-approved mortgagees – not independent contractors.
HUD further clarifies that “[t]he The Mortgagee may establish a Sponsor/Sponsored Third-Party Originator (TPO) Relationship in which a Mortgagee (acting as the “sponsor”) permits another entity to act as an originator and originate Mortgages on behalf of the Mortgagee.”
III. IRS – Common Law Rules
While there are multiple tests utilized in various arenas which help determine the proper classification (i.e., independent contractor vs. employee), the IRS provides additional guidance in Publication 15-A (2022) under the Common Law Rules section:
“To determine whether an individual is an employee or an independent contractor under the common-law, the relationship of the worker and the business must be examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties.”
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
This refers to “facts that show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.”
Here, the key element is that as the mortgage banker or broker, you have the right to direct and control the work of the licensee who you have sponsored. This balances on the side of an employer-employee relationship would not permit paying an MLO by 1099.
- Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Financial Control refers to refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job. This factor includes analysis under services available to the market which states that:
“An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.”
Here, the independent contractor’s location would be either a main office or branch location licensed under the NMLS, and because this would be the organization itself who maintains the visible business location, and not the MLO, this would balance in favor of the MLO being classified as an employee and not an independent contractor.
- Type of Relationship: Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Under this factor, it includes that “[i]f a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities.”
Here, because the loan production of an MLO would be a key aspect of a mortgage business, this would support that an MLO would be considered an employee and could not be paid by a 1099.
Conclusion
Based on the guidance provided and the foregoing balancing of the factors included in the IRS Common Law Rules section, it does not appear reasonable to classify MLOs as independent contractors which show that an MLO could not be paid by 1099.
Thus, it is critical to properly classify your MLOs because a failure to do so may result in expensive penalties!
Sean A. Stephens, Esq., CMB®
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