Understanding Whether a Mortgage Loan Originator Can be Paid via a 1099

The question of whether a mortgage loan originator (MLO) can be paid via 1099 is a topic of confusion in the industry. Although some states permit MLOs to be paid by 1099, the IRS must classify them properly. If an MLO is misclassified as an independent contractor when they should be an employee, significant ramifications may arise. While there is no federal regulation mandating that all MLOs should be paid a W2, HUD prohibits FHA-approved Mortgagees from using non-employees as loan originators. To determine whether an MLO can be paid by 1099, the mortgage banker or broker must consider behavioral, financial, and type of relationship factors as per the IRS Common Law Rules.

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.”

  1. 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 balance on the side of an employer-employee relationship would not permit paying an MLO by 1099.

  1. Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how the 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.

  1. 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 “if 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.

In conclusion

 the issue of whether a mortgage loan originator (MLO) can be paid via a 1099 is a topic of confusion in the industry. While some states permit MLOs to be paid by 1099, the IRS must classify them properly. If an MLO is misclassified as an independent contractor when they should be an employee, significant ramifications may arise. There is no federal regulation mandating that all MLOs should be paid a W2, but HUD prohibits FHA-approved Mortgagees from using non-employees as loan originators. To determine whether an MLO can be paid by 1099, the mortgage banker or broker must consider behavioral, financial, and type of relationship factors as per the IRS Common Law Rules. Overall, it is essential to properly classify the MLO as either an independent contractor or an employee, and the mortgage banker or broker should consult with a legal or tax professional to ensure compliance with applicable laws and regulations.

FAQ

What is the confusion around mortgage loan originators (MLOs) being paid via 1099?

It is unclear whether MLOs can be treated as independent contractors and paid via a 1099.

Why is paying an MLO through a 1099 advantageous for the banker or broker?

It provides a significant payroll cost saving compared to paying an MLO as a W2 employee.

Are all states in agreement about paying MLOs through 1099?

No, even in states where it is permitted, the MLOs must still be properly classified as determined by the IRS.

Can an MLO be classified as an independent contractor under federal laws?

While there is no specific federal regulation that mandates all MLOs to be paid a W2, it depends on the nature of the relationship as per the IRS Common Law Rules.

What is the Loan Originator Compensation Requirements under the Truth in Lending Act?

It includes both individual originators who are employees or independent contractors.

Is it sufficient to rely solely on the guidance of the Loan Originator Compensation Requirements to determine whether an MLO can be paid by 1099?

No, the mortgage banker or broker must still properly classify the relationship according to the IRS Common Law Rules.

Can an FHA-approved Mortgagee use non-employees as Loan Officers?

No, they may only use W2 employees to originate loans.

Can a Mortgagee establish a Sponsor/Sponsored Third-Party Originator (TPO) Relationship?

Yes, but the Mortgagee must act as the “sponsor” and permit another entity to act as an originator and originate Mortgages on behalf of the Mortgagee.

What are the IRS Common Law Rules?

Answer: The IRS provides guidance to determine the proper classification (i.e., independent contractor vs. employee) in Publication 15-A (2022) under the Common Law Rules section.

What are the three categories of facts that provide evidence of the degree of control and independence according to the IRS Common Law Rules?

Behavioral control, financial control, and the type of relationship of the parties.