To gross up nontaxable income, a lender adds an extra amount, commonly 25 percent of the untaxed figure, to bring it level with taxed wages before calculating the debt ratio. A $2,000 monthly benefit becomes $2,500 of qualifying income. The borrower must prove the income is not taxed and is likely to continue.
How do lenders gross up nontaxable income?
The lender multiplies the nontaxable monthly amount by 1.25, or adds 25 percent of it, and uses the result as qualifying income. The logic is fairness: debt ratios are built on gross wages before tax, so untaxed income would otherwise look smaller than an equal take-home pay. Some lenders allow a larger adjustment when actual tax rates justify it.
The 25 percent figure comes from agency rules. The Fannie Mae Selling Guide section on general income information tells lenders to develop an adjusted gross income by adding an amount equal to 25 percent of the nontaxable income, when the income and its tax-exempt status are likely to continue. It also allows a higher amount if the taxes a wage earner in a similar bracket would pay exceed 25 percent. Bank statement lenders are not bound by that guide, but many follow the same convention.
Worked example
The figures are an example. A self-employed borrower qualifies on $7,600 a month of bank statement income. Her co borrower receives $2,200 a month in Social Security, documented as nontaxable for him.
| Line | Example amount |
|---|---|
| Bank statement income, borrower | $7,600 |
| Social Security, co borrower | $2,200 |
| Gross up at 25% | $550 |
| Grossed up Social Security | $2,750 |
| Combined qualifying income | $10,350 |
| Monthly obligations including housing | $4,500 |
| Debt-to-income ratio with gross up | 43.5% |
| Debt-to-income ratio without gross up | 45.9% |
The gross up lowers the ratio by more than two points, which can be the difference at a program limit. How the second person's income and debts enter the file is covered in the guide to a co borrower bank statement loan.
Social Security, disability and other nontaxable income types
Nontaxable income is income the borrower does not pay federal income tax on. Common candidates are Social Security benefits below the taxable threshold, some disability benefits, certain military allowances, child support and some public assistance. Whether a particular payment is untaxed depends on the borrower's situation, not only on its type.
Social Security is the clearest example of why. The IRS explains that benefits may be taxable when one-half of the benefits plus all other income, including tax-exempt interest, exceeds a base amount set by filing status; its IRS answer on whether Social Security benefits are taxable lists $25,000 for single filers and $32,000 for married couples filing jointly. A retiree with little other income may pay no tax on benefits. A working spouse with a large salary may pay tax on part of them.
That matters for bank statement files, because a self-employed borrower's business income can make a spouse's benefits partly taxable on a joint return. Only the untaxed portion is a candidate for the gross up.
Deposits of these benefits show up clearly on statements, usually with a government payer name on a fixed date. Verifying the benefit itself still needs its own document, which is covered with other income checks in bank statement income verification.
Proof that the grossed up income is nontaxable
The borrower proves income is nontaxable with a document that shows its tax status. Fannie Mae's guide lists award letters, policy agreements, account statements, tax returns or any other documents that address the nontaxable status. A recent federal tax return that shows the income went untaxed is usually the plainest proof.
Documents that usually work
- The latest tax return. Shows benefits received and the taxable amount. An untaxed amount is the plainest evidence.
- An award letter. States the benefit, and for some programs, its tax treatment.
- A benefit statement for the year. For Social Security, the annual statement shows the total paid, which can be matched to the return.
What a bank statement alone does not prove
A statement shows the deposit arrived. It does not show whether the borrower paid tax on it. A lender that grosses up on the strength of a deposit alone is accepting a risk most guides do not permit. Collect the tax document before quoting the grossed up figure.
When should you not gross up nontaxable income?
Do not gross up income that is taxed, income already counted at a grossed up figure, or income that will not continue. Under Fannie Mae's rule, income with a defined end date must be expected to last at least three years from the application to count at all, so a benefit ending sooner cannot be grossed up.
Cases to watch
- Partly taxable benefits. Gross up only the untaxed part, not the whole amount.
- Double counting. A lender worksheet may gross up automatically. Adding 25 percent by hand on top doubles the adjustment.
- Bank statement income. Business deposits are taxable income to the owner, even if the tax return shows little profit. They are never grossed up.
- Short continuance. Benefits ending within three years, such as some survivor benefits for a child near adulthood.
Gross up is a mortgage convention. Lenders who size loans from cash flow, such as farm lenders working through agricultural loan underwriting, read the cash the operation produces instead. Files that combine a salary with self-employment income raise their own adding-up questions, covered in combining W-2 and self-employed income.
TrueBankFlow groups deposits from the same source on a regular schedule with their cadence and average amount, so a benefit payment is easy to pick out from business deposits. You can see how recurring income is grouped.