How to Avoid Common Mistakes When Calculating Annual Income

April 12, 2012

Annual income is an important factor that influences the eligibility of an applicant for the tax credit program. To become income eligible, an applicant's household gross annual income must be equal to or less than the income limit applicable to your site.

The governing regulations for the tax credit program require site owners to use the rules found in HUD Handbook 4350.3 to calculate the annual income of applicants and residents. How you calculate a person's annual income depends on his age, whether he is an “adult” or a “dependent,” as defined by HUD.

We'll give you eight rules to follow to avoid common errors when calculating annual income for applicants and residents. Calculating income correctly will help you avoid costly certification mistakes that could put the owner's tax credits at risk.

Rule #1: Download HUD Handbook 4350.3, Chapter 5

You can download an electronic version of Handbook 4350.3, Chapter 5, at www.hud.gov. Through its electronic library, HUD provides all of its active handbooks and notices. In Section 1 of Chapter 5, HUD describes how to calculate annual income for applicants and residents at HUD-assisted sites.

You should also be sure to download Exhibit 5-1, Income Inclusions and Exclusions, in HUD Handbook 4350.3. This list tells you the types of income to include in a household's gross annual income. Refer to this list because there are too many types of income an applicant or resident could have for you to remember.

Rule #2: Verify Each Household Member's Age

How you calculate a household member's income depends on his age. To calculate income correctly, you must document the age of every person in a household:

Include the earned income of a person who's at least 18 years old.
Exclude the earned income of a person who's not yet 18 years old, unless he's the head of household, co-head of household, or spouse of the head of household.
Include the person's unearned or benefit income, regardless of the person's age. For example, include the Social Security and disability benefits, and the trust income of a person, regardless of his age.

Rule #3: Don't Assume Household Member Isn't Full-Time Student

Full-time students come in all ages. A person of any age can decide to go back to school on a full-time basis. Don't assume that someone over the age of 25 cannot be a full-time student. Always document a student's status with his school:

If the school says the resident has full-time status, classify him as a full-time student.
If the school says the resident has part-time status, classify him as a part-time student.

Remember that how you calculate a student's earned income varies depending on whether he's a full-time or part-time student:

If a full-time student is the head of household, co-head of household, or spouse of the head of household, include all his earned income in the household's annual income calculation.
If a full-time student isn't the head of household, co-head of the household, or spouse, include only the first $480 of his earned income in the household's annual income calculation.
For a part-time student, include all of his earned income in the household's annual income calculation.

Rule #4: Don't Assume Who Head of Household Is

Never assume that you know who the head of a household is. Many managers mistakenly think they know who the head of a household is based on personal characteristics. Remember the following rules:

The head of household is not based on a person's gender.
The head of household is not automatically the oldest person in the household.
The head of household is not automatically the person who makes the most money.
The head of household does not need to have earned income or receive benefits from the Social Security Administration.
A person who's more than 18 years old is not automatically the co-head of household.

Let the applicant tell you who the head of household is. And remember that whether or not someone is the head of household, co-head of household, or spouse of the head of household affects how you calculate his income:

Include the earned income of anyone who's the head of household, co-head of household, or spouse of the head of household.
If someone is a full-time student and also the head of household, co-head of household, or spouse of the head of household, include all of his earned income.
If someone is an emancipated minor and the head of household, co-head of household, or spouse of the head of household, include all of his earned income.
If someone is an emancipated minor, but is not the head of household, co-head of household, or spouse of the head of household, exclude all of his earned income.

Rule #5: Verify Whether Person Is Paid Twice per Month or Every Two Weeks

Many employees appear to receive their paychecks twice per month. But some employers pay their employees twice per month, and others pay their employees every two weeks. To calculate annual income correctly, you must verify the following:

Is a person paid twice per month? For example, does she receive a paycheck on the first and 16th of every month? If so, she has 24 pay periods. You may calculate her annual income by multiplying her gross pay per pay period by 24.
Is a person paid every two weeks? For example, does she receive a paycheck every other Friday? If so, she has 26 pay periods. You may calculate her annual income by multiplying her gross pay per pay period by 26.

Example: Sammie Smith receives his paycheck from his employer on the first and 16th of every month. His gross pay per pay period is $1,200. His gross annual income is $28,800 ($1,200 x 24 pay periods).

Example: Judy Johnson receives a paycheck from her employer every other Wednesday. Her gross pay per pay period is $1,200. Her gross annual income is $31,200 ($1,200 x 26 pay periods).

Rule #6: Correctly Calculate Income from Assets

Remember that a resident's income includes the income generated by his assets. Use the following rules to calculate income from assets:

Calculate the cash value of each asset owned by a household member.
Add up the cash value of all of the household's assets.
Calculate the actual income each asset will generate in the following 12 months.
Total the income all the household's assets will generate in the following 12 months.
If the total cash value of the household's assets is more than $5,000, calculate the imputed income from the assets by multiplying the total cash value of the household's assets by 2 percent.
Include the greater of the total actual income from the household's assets or the imputed income from the assets in the household's annual income.
Never include the cash value of a household's assets in the annual income calculation.

Example: Ms. Green has a $2,000 savings account and an average balance of $500 in a noninterest-bearing checking account. The savings account carries an interest rate of 2.5 percent. The income from her assets is $50 ($2,000 x 2.5%). Do not calculate the imputed income of Ms. Green's assets, because the total cash value of her assets ($2,000 + $500) is not more than $5,000.

Example: Mr. Blue has $3,000 in a savings account and an average balance of $700 in a noninterest-bearing checking account. The savings account has an interest rate of 2.5 percent. He also has $4,000 in a certificate of deposit (CD). The CD carries an interest rate of 4 percent and has a premature withdrawal penalty of 5 percent. The cash value of Mr. Blue's assets is $7,500 [$3,000 + $700 + ($4,000-5%, or $3,800)].

The total actual income from Mr. Blue's assets is $235 [($3,000 x 2.5%) + ($4,000 x 4%)].

Because the cash value of Mr. Blue's assets totals more than $5,000, calculate the imputed income from his assets: $7,500 x 2% = $150.

The total actual income from Mr. Blue's assets, $235, is greater than the imputed income from his assets, $150. Include $235 in Mr. Blue's total annual income.

Note that you must include the income from assets owned by minor members of a household. For example, the interest generated by a child's savings account is included in the household's annual income.

Rule #7: Include Gross Social Security Benefits

Correctly calculate annual income from Social Security and Supplemental Security Income (SSI) disability benefits. Use the following rules to correctly calculate income received from the Social Security Administration:

Include a person's gross monthly Social Security benefit in his annual income calculations.
Do not subtract the monthly Medicare premium the government takes from a person's Social Security benefit, before calculating his annual income.
Some low-income residents receive a benefit from the government to help pay their prescription drug insurance premium through the Medicare Part D program. This payment may be added on to the recipient's monthly Social Security benefit, but do not include it in his annual income.
Make a copy of a recipient's Social Security award letter to document his gross monthly Social Security benefit.

Rule #8: Correctly Calculate Income for the Self-Employed

It can be more complicated to calculate annual income for a self-employed person. You can't verify his income through a third-party employer. And, unlike someone who receives Social Security benefits, a self-employed person doesn't have a benefit award letter to document his income.

Calculate the income of a self-employed person by subtracting his business expenses from his gross business revenue to determine his net business revenue. As with all types of income, include the income a person receives before paying any taxes. But, for a self-employed person, deduct his business expenses first.

Example: A day-care provider receives income from her clients of $2,500 per month. She pays $1,000 per month for supplies and insurance. Her net business revenue is $1,500 per month.

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Income Calculations