Figuring Income When Some Is Tax Exempt

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Question:

Does a Tax Service fee have to be included on the TIL disclosure? In a highly reputable banking compliance publication that shall remain unnamed, I recently read an article entitled "Grossing Up Public Assistance Income". In this article it stated "Under ECOA, while making loan approval decisions, banks must not discriminate against applicants who receive public assistance income. Generally this income is exempt from federal income taxation. If the income is exempt from taxation, then before making a loan approval decision, this exempt income needs to be grossedup to a pretax, taxable incomeequivalent amount." The article goes on to say that a "client bank" was written up for not doing this and the examiners also said that this also needed to be spelled out in the bank's loan policies and procedures manual. I've read every word in my Federal Reserve Manual under Regulation B, to include the commentary, and can find no reference to this. In the past, we have always considered this to be a "gross" income since it was not t axed. I have a HMDA related loan that has an sole income source of Social Security Benefits and need to know what my "gross" income figure is. I would appreciate any assistance that you could give me in light of this new information. Thank you in advance for your help.

Answer:

Grossing up income is a fair lending practice under ECOA and/or the Fair Housing Act. For HMDA, use real numbers.

As for guidance on when and how to gross up income, the only place you will find it discussed is in the fair lending examination procedures.

I am aware of several situations when banks were criticized for not grossing up untaxable income. Whether grossing up is a necessary or appropriate practice depends on how you consider income. The theory behind it is that untaxed income is worth more because the borrower doesn't lose any to Uncle Sam on April 15th. So if you are underwriting loans using a cash flow analysis with net income, grossing up won't be necessary. However, if you are evaluating the adequacy of income and in the process making assumptions about taxes, then you should take steps to compensate for untaxed income.

Another situation I have seen is a criticism that the bank failed to gross up income when the income was not needed to qualify for the loan. The loan was approved without the extra consideration. Clearly, in this situation, the applicant was not harmed and grossing up should not have been an issue.

First published on BankersOnline.com 12/1/03