Part 2: Defining Who is "Low Income"
In the first article in our Back to Basics series we discussed the importance of having a full “toolbox” of regulatory information at our fingertips. This powerfully assists us in effectively managing compliance at tax credit properties. Suggestions were made as to various handbooks and other specific documents to have on hand or on our computers. In this second article we will now use one of those tools to gather information on a crucial topic. The topic is defining income for households at tax credit properties. The tool that we will use is the HUD Handbook 4350.3 found HERE.
Why income matters
Affordable housing is designed to help households that are at or below certain income limits. Various programs have different limits. For the tax credit program, the federal income limits for a property are the Multi-family Tax Subsidy Program (MTSP) limits. State tax credit allocators can add additional, lower, set-aside limits to a property. Determining the limits applicable to a specific property is a topic for an entire article in itself, but each household needs to be below the applicable MTSP income limit at move in. Proving that each household meets this income test is required, along with charging rents below rent limits and maintaining units as decent, safe and sanitary. All of these must be true of a unit that is used to claim tax credits. For example, we may charge appropriate rents on a beautifully maintained unit but if we move in a household that is over the income limit, tax credits may not be claimed. Clearly we want to understand how income is calculated to avoid moving in over-income households to keep our tax credits secure. On the other hand, we could also count too much income and deny households that the program is actually designed to help while causing unnecessary vacancy loss. Either way, we want to do what is right for our properties and our applicants. Doing this in a fair manner involves being well educated on the income determination rules.
Where are the income rules?
Who gets to decide how we define income? As the tax credit program is ultimately under the supervision of the IRS, do we use taxable income and IRS rules? To this day, this confuses some professionals, but the answer is “no.” At the outset of the tax credit program, HUD’s definition of income was adopted. Despite the IRS connection, the regulation clarifies:
"Tenant income is calculated in a manner consistent with the determination of annual income under Section 8 of the United States Housing Act of 1937 (Section 8), not in accordance with the determination of gross income for federal income tax liability” (IRS Notice 88-80 and IRS regulation 1-42-5 (b)(1)(vii)).
So HUD rules are important here. The IRS even tells us that, although they try to publish helpful information on income calculation for purposes of the tax credit program, if HUD rules change when it comes to income, then published IRS guidance becomes obsolete (8823 Guide 1-2). Obviously, when it comes to the definition of income, HUD is where we look for guidance. The HUD handbook, linked above, is the authority on HUD rules.
Major categories of income
The HUD Handbook broadly categorizes income into three main types: earned, unearned and asset income. As the name indicates, earned income is income from employment, self-employment and military pay. Unearned income includes periodic benefit amounts like social security or pensions. It also includes welfare assistance and periodic and determinable allowances such as alimony and child support. Asset income is income that is received from assets, or in the case of retirement accounts, when periodic withdrawals are made from the accounts. Two nice tools are available in the HUD Handbook that gives further detail within these broad categories. They break income down into 9 specific types and assets into 10 types. They clarify what we include as income and also what we exclude. These tools are Exhibit 5-1 (income) and Exhibit 5-2 (assets). They are drawn directly from HUD regulations and are available with the other parts of the HUD handbook as linked above. Please be aware that the underlying regulations are at times updated and the Exhibits may have some out-of-date information. For this reason, it is also good to have access to the regulations themselves online, such as those available HERE. The Exhibits, however, give further explanation to many inclusions and exclusions to income and assets and are therefore still very useful.
For most households, all earned, unearned and asset income is counted. Why does HUD break down income in these broad categories? It is because we treat earned income differently for dependents. Dependents in HUD rules are minors and adult full-time students who are not head, co-heads or spouses of the head of the household. Generally, they are minor or adult student children of the household. For minors we count NO earned income. For adult dependents, we count up to $480 of their earned income annually. For example, if a 16-year-old dependent son of a household makes $10,000 a year as a dishwasher at a local restaurant, all of the income is excluded. His 19-year-old sister, who is a full-time student dependent may do a similar job and only $480 of the income annually is counted. The rest is excluded. However, if either of the dependents is getting unearned income, such as social security, all of that income is counted, as is all asset income. For households with these dependents, this can make a major difference in household income and it is important to be well educated in these rules when determining if a household is eligible for a tax credit unit. Of course, there are many further details on income and assets in the HUD Handbook, and these are primarily found in Chapter 5. Tax credit professionals must know this chapter very well.
A word of caution
As you dig deeply into HUD guidance and regulations, you will probably realize that there are areas where many professionals in the tax credit industry impose additional rules. This is the case generally in areas where the HUD rules, which allow as many recertifications as necessary to ensure accuracy, creates uncertainty for the tax credit program, which only tests income eligibility at move-in. Rules created to deal with this uncertainly vary by state, management company or even property owner and investor. It is beyond the scope of this article to discuss all of these variations but we can list a few examples. A common area where additional rules are imposed are when there is a range of hours listed on a verification from an employer, and instead of counting the average (per HUD procedure) we may be required to count the highest number in the range. Also debated is how to handle unsecured income that a household is seeking and may or may not get such as jobs sought while a person is unemployed but applying to live at a property. A final example is that there are varying opinions on whether annualized year-to-date numbers must be used if these exceed what the employer anticipates paying in the next 12 months. HUD does not speak to these issues, so there are no “black and white” answers. Savvy tax credit professionals learn to navigate these issues with their state agency, company compliance officer or owner/investors.
As we can see, our “toolbox” of useful guidance serves us well. We have seen how just two Exhibits to the HUD Handbook provide a wealth of information on income and assets, a crucial topic to understand for tax credit professionals. Please read the next Costello Blog post in which we will tackle another compliance basic and see how or regulatory “toolbox” gets us the right answers!
This and other topics (basic and advanced, tax credit and other programs) are covered in our in-person and webinar courses. Check out the schedule HERE.