While it’s not difficult, many people just “guess” if a borrower’s income qualifies to be grossed up. I wanted to discuss this and remove the guessing and break down the why, what, and how of grossing up income.
Why to gross up income?
The debt ratios set by all entities that loan money (mainly Fannie/Freddie) base their ratios on taxable income. For example most loans run through DU will not approve with a DTI over 45%. The remaining 55% of income is for a family to pay for items not considered in the debt ratio such as food, insurance, day care, and taxes to name a few. Because the average American family pays around 25% of their income in taxes, conventional guidelines allow a 25% “gross up” of the non-taxable income. Please note, government loans require you to determine the precise tax bracket for the borrower and not assume 25%. This guideline corrects the formula for the few forms of income that are not taxed by the government.
What to gross up?
What kind of income is tax free? The most common forms are child support and social security income. AllRegs also cites that any income that meets the general requirements (for most 2 years history and 3 years continuance) that can be documented as tax free can also be grossed up. For this blogger…. There are very few forms of income I can think of that the government will not tax.
How to gross up income?
So how do you know if an income can be grossed up, follow these guidelines.
Child Support
Since the person paying the child support transfers the money after tax, the person receiving does not pay taxes in 99.9% of the cases.
Social Security Income
Per IRS laws social security is taxed based on the overall household income, borrowers will fall into two categories
1) A borrowers household will only have social security income, and will not file a tax return (since all their income comes from Social Security, no tax returns are needed)
2) A borrower’s household will fall into the sliding scale of 0% to 100% of the social security income taxed. When reviewing the borrower’s 1040’s line 20A will show the gross income received, and line 20B will show the amount taxed. Line 20A represents all of the social security income received in the household, and line 20B shows the amount of that income that is taxed. If line 20B is blank you can gross up the full income. If line 20B has any number you need to figure out the % of income that line represents of the total income and only gross up the reaming amount, here is an example
$20,000 line 20A / $10,000 line 20B = 50% of the income is taxed. After determining that 50% of the income is taxed you can still gross up the remaining 50% of the income (50% of line 20A is $10,000 … $10,000 x 25% = $2500… total income is $22,500/ 12
Wrapping it up, not a really difficult set of math but we hope this takes any mystery out of the “what, how, and why of grossing up income. If you want a free online tool for doing these calculations, take a look at UberWriter. We built Uberwriter to make all the math and final income calculations much easier. Check out UberWriter at www.blueprintio.wpengine.com and see how much easier your income calculations can be!
We appreciate your feedback and comments!
Do you have a calculator that can be used to quickly determine when both borrowers are receiving ss income and some of it is non taxable and some not what percentage of each can be grossed up?
Hi Anthony
UberWriter includes multiple kinds of gross up calculators. You can sign up for our free basic subscription and use the SS/Disability calculator which will provide you with a tool to only gross up the non taxable portion of the return. Maybe you can tell Casey about this great tool and all of Movement Mortgage will benefit! Keep up the great work there I always enjoy seeing the youtube videos about your company.
What about grossing up a 100% disabled veterans pay, all non-taxable, for a consumer loan DTI qualification. It seems like the right thing to do, but I can’t find a bank that will allow it. I would understand if they were to treat everyone’s qualifying income as net instead of gross, but that is not the case. Seems like discrimination to the disabled veteran.
Tax Returns are jointly filled by B and CB. SSI used for borrower and co-borrower for qualifying purpose. SSI Award Letter is available for the both and income reported on Tax Returns as well.
My approach is : As verified from Tax Returns that only 40% of the total SSI income is non-taxable (Line#20a-Line#20b=Non Taxable/Total Income (Line#20a). Hence, grossed up only 40% of the income reported on Award Letter.
Please suggest or share if you have any other way to gross-up the income, in this scenario?
HI Sanjeev
That is exactly right the way you stated. You have reviewed the tax return, determined the amount of taxable versus non taxable and grossed up only the taxable amount of the award letter. Great job!
Thanks
Michael Whitbeck
HI Michael,
do you know if State Retirement Pension income and Income from an Annuity would be considered non-taxable to FHA so I can gross it up? I only saw SSI, and could not find State pension or Annuity in their guidelines.
Hi Adriana
The key to grossing up any income is documenting that it is non taxable. The guidelines remain a bit vague because they want to leave room for different situations. Provide evidence (tax returns or letters from the payor or IRS codes / state laws) on the book confirming it is non taxable and you should be good to go.
Thanks!
MIke
Hi Michael,
Please clarify… So if the Borrower is receiving SSI income and does not have to file taxes does that mean we can then gross up all the SSI income by 25%?
Example: Borrower receives $2,000.00 SSI and since this is her only source of income she does not need to file taxes. So do I take the $2,000 x 25% = $500.00 + $2,000 = $2,500 total qualifying income??
AuDrina, I came from a processing position, to underwriting. I have 5 years in total processing experience and 2 years of sales in between. At my current employer, my buddy and I were the first wave to be considered for the role. Of course, we were put through a quick internal training progrma and were given the opportunity to test to acquired our SASE UW authority. We did so well that most of the UW hiring is now done internally. It’s cheaper for the company because they can pay entry level wages. The problem is that many processors become complacent and become robots at pushing conditions to UW for sign off. Many are petrified with audit finding and are scared to sign off on a simple LOE. I believe some are just overly swamped with files that cannot put the time to learn or even question why certain conditions are being requested. Other, simply want to push files without putting their level 2 authority on the line. At some point or another, we are bound to err. Just a matter of building confidence and learning from mistakes.
Formula is not right – it is the non-taxable amount minus the taxable portion times 25% plus the taxable portion divided by 12.
example $20,000 minus $10,000 = $10,000X25%= $2,500 + $10,000 = $12,500 /12 = $1,041.67
Hi Dianna
Thank you for your comment, in regards to the math the blog example is correct. Line 20A represents all of the SS income the borrower has earned which in my example is $20,000, Line 20B showed that of the $20,000 , $10,000 can be “grossed up”. We then gross up the non taxable portion of $10,000 x 25% gross up rate to get $2,500. So the final math to determine the usable income (grossed up) is $20,000 (line 20A) + Grossed up amount of $2,500 = $22,500 / 12 months = $1,875 per month. In your example of 12,500 you are only representing the taxable amount with the gross up ($10,000 + $2,500 /12 = $1041 .67) which does not give the borrower full credit for their income.
I reviewed the wording on the blog that appears to be what I have on their, but if I have missed something let me know, I sincerely do appreciate the dialog!
Thanks
Michael
Hello Michael,
Howdy from an LO in McKinney, TX! I have no idea if you are still answering this blog but thought I’d try. I have a question about line 20b. You said if the line is blank you gross up the whole income but is 0 the same as blank? In other words if they had dividend income that they wrote off would 0 mean 0. Or would 0 be 100%, I hope that I’m making sense and that you are still answering! 🙂
Hi Billy
Thanks for the question, on the tax form 20A is the actual income and 20B is the taxable portion. If there is a $0 in 20B that means all of the income on 20A is non taxable so you would take 20A x the gross up rate / 12 months to determine the monthly income.
Regards!
Michael
Your example of grossing up is wrong. Total income in the example is not $12,500 / 12, it is $22,500 / 12
Whoa good catch Noel that was a typo you are correct it is $22,500 /12 thank you for pointing that out!
I am confused now… in your example only the remaining income is to be grossed up by 25%, the remaining income in your example is 50% of $20,000. which should actually be $10,000? x 25%= $2500. therefore should be $10,000. plus $2,500. = $12,500.Total / 12 = $1,041.67 monthly.
Please clarify.
Hi Connie
Here is the math, total income is $20,000 if only $10,000 is non taxable the formula would be $10,000 x 25% = $2500(this is the “gross up” allowed). Total income $20,000 + $2500 allowable gross up = $22,500 / 12 = $1875 per month. Does that make sense? Let me know! Thanks for the comments.
no this calculation is not right.
Hi Connie
Here is the math, total income is $20,000 if only $10,000 is non taxable the formula would be $10,000 x 25% = $2500(this is the “gross up” allowed). Total income $20,000 + $2500 allowable gross up = $22,500 / 12 = $1875 per month. Does that make sense? Let me know! Thanks for the comments.
As a member of the clergy our housing or parsonage allowance in not taxable.
So if I have a social security awards letter, and I know the SS is non-taxable income, what is the amount I can gross? A) the total monthly amount before deductions (such as medicare) or B) the amount received after deductions?
I so agree with the processing and uw thing. I started at the bottom and worked my way up to a DE underwriter. I think processors have it very hard and do not get enough credit. They have to deal with borrowers, underwriters, title Co.’s, appraisers, ins Co’s etc. I have no desire to process again.
Michael,
A few more forms of income that are not taxable would be long term disability, VA disability, Military Housing allowance (BAH), Military Substance Allowance (BAS). I will also point out that if you are underwriting a VA loan, or a manual underwrite FHA, and you do gross up any non taxable income that you deduct the amount it was grossed when you are determining residual income
Hi Dave
Excellent points, thanks for the contribution, when I was writing the article it really was hard to think of common non taxable incomes, but the few you pointed out definatley fit in the box!
Hi AuDrina
That is a great question, and my answer will make a lot of people in underwriting mad. My answer… any company that does not have a training, testing, and mentoring system is blowing it. Guess what setting that up takes allot of hard work, but going around the shallow pool of underwriters in your market and passing back and forth the B and C level underwriters is also hard work (they keep getting cut for a reason) Any company would save themselves thousands of dollars and countless hours of frustration if they would learn to train and teach their own underwriters.. in baseball that is called a “farm team”. So I am 100% in agreeance with you… a person should start as a processor, move to junior underwriter, then underwriter, then senior underwriter, there is no reason in the world you could not train and monitor people to do that.
Now the trick is…finding a company that has the vision to make that happen. I was trying it in my last company and the board members were too short sited and did not fully understand how underwriting works to accept a program.
Thanks for the question
Hello Mr. Michael, if all of the companies are requiring at least four to five years experience for Underwriting, how can processors ever get the experience. The only difference is really the signing authority. Processors that have been around a while know how to calculate income even from a self employed borrower, etc. Companies are not willing to give processors the chance to become underwriters.
Thank you,