We see that our search traffic is asking questions about grossing up income, so we decided to put this article together to help answer this common question. Although not difficult, many people just “guess” if a borrower’s income qualifies to be grossed up. This article’s main purpose is to inform and educate on how to gross up, what is eligeable to be grossed up, and why you would want to gross up an income.
Why do we gross up income?
The debt ratios set by all entities that loan money (mainly Fannie/Freddie in our case) base their ratios on taxable income. Because the average American family pays 25% of their income between federal and state taxes conventional guidelines allow 25% “gross up” of the non taxable income. Note that government loans require you to determine the actual tax bracket. For example most loans run through DU will not approve with a DTI over 45%. The 55% of the remaining income is room for a person or family to pay for items not considered in the debt ratio such as food, insurance, day care, and taxes to name a few. What this guideline does is correct the formula for the very few forms of income that are not taxed by the government.
What income can I gross up?
What kinds of income are 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. Based on this, there are very few forms of income I can think of that the government will not tax.
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
- 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.
- 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 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.
How do I gross up the income?
Let’s work an example to demonstrate how this is done:
$20,000 line 20A / $10,000 line 20B = $50% of the income is taxed. After determining that 50% of the income IS taxed , by default the remaining 50 % is not taxed and can be grossed up. Here is how the math works ($10,000 x 25% non-taxable portion of the income = $12,500) +( $10,000 the taxable portion )= $22,500 / 12 months = $1875 per month to qualify.
Here is what that would look like in UberWriter.
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. We have built software to take the guess work out of income calculations. Go to www.blueprintio.wpengine.com to learn more about how the income calculation problem has been solved.