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.
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!
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