Four Tips to Avoid Mistakes in Tax Credit Calculations
A key aspect of your job as a tax credit manager is performing calculations. For instance, you must perform calculations to correctly determine whether a household is eligible to occupy a low-income unit, how much rent you can charge, and how many low-income units you need to set aside at your site. When performing these calculations, it’s easy to make mistakes. And because the tax credit program requirements are very precise, even one small mistake can cost the owner its tax credits.
To help you avoid making mistakes, we’ll give you four tips you should follow when performing tax credit calculations at your site.
Tip #1: Round Correctly When Results Aren’t Whole Numbers
It’s possible that you won’t get a whole number result from your tax credit calculations. For instance, say you need to rent 40 percent of your building’s units to qualified low-income households to meet the building’s minimum set-aside. If you have 28 units, that would amount to 11.2 low-income units. Do you then round up or down to determine how many low-income units you should rent?
You might not think that whether you round up or down is important. But if you round in the wrong direction, you could cause your site to fall into noncompliance.
When to round down. Always round down when calculating any maximum, such as the maximum allowable rent. Rounding up would mean charging more than the tax credit law allows. And charging even one dollar more than the maximum could trigger noncompliance.
When to round up. Round up in the following two situations:
When calculating any minimum. Round up when calculating any minimum, such as the minimum number of units you must rent to qualified low-income households. In the example above, if you determine that you must rent 11.2 units at your building to qualified low-income households, rent at least 12 units to such households. You might think that it’s okay to round down to 11 because that’s the closest whole number to 11.2. But because 11.2 is the minimum, rounding down to 11 would cause you to not meet your building’s minimum set-aside and to jeopardize all the owner’s tax credits.
When calculating household income. Households are eligible to occupy low-income units only if they earn no more than the income limit. If a household earns more than the limit, it’s not eligible and you mustn’t round down to make the household eligible. If your state housing agency discovers that you rounded down, it could cite you for noncompliance and put the owner’s tax credits at risk.
For example, suppose the income limit for a two-person household in your area is $21,400, and you calculate a household’s income to be $21,400.23. Although the household earns less than a dollar over the limit, it’s still over income. If you round down to $21,400 and rent a low-income unit to that household, you risk noncompliance if your state housing agency discovers your calculations.
Tip #2: Use Prorated Fraction to Calculate First-Year Credits
If you’re managing a tax credit site in the first year of its credit period, calculate a “prorated fraction” for each building to determine how many credits the owner may claim in the first year. According to IRC Section 42(f)(2), an owner isn’t allowed to take the entire credit a building is expected to produce each year in the tax credit program on his tax return for the first year of the tax credit period.
The number of credits an owner can claim in the first year depends on the percentage of a building’s units rented to low-income households during each month of that year. Each month that the building wasn’t in service for the full month is averaged in as a zero, reducing the fraction.
This percentage is known as the prorated fraction. The owner must use the prorated fraction rather than the first-year applicable fraction to calculate how many credits it’s entitled to claim in the first year. The first-year fraction only establishes the lower limit that each following year’s applicable fractions must meet to avoid putting the owner’s credits at risk. It’s not used to calculate credits.
It’s important for an owner to obtain the right prorated fraction and claim the correct number of credits. If the owner claims too many, it can get into trouble with the IRS. And if the owner doesn’t claim all the credits it’s entitled to because calculations were off, the owner may hold you responsible.
Tip #3: ‘Impute’ Household Size to Calculate Rents When Using Number-of-Bedrooms Method
If you use the number-of-bedrooms method to calculate rents for your low-income units as most tax credit managers do, you must first convert the number of bedrooms in each unit to an “imputed” or assumed household size. You must do this because the income limits you use in your calculations are organized by household size. Some LIHTC projects developed with 1987, 1988, and 1989 allocations use household size instead of bedroom count to set maximum rents. However, all projects developed since 1990 use the bedroom count method, not actual household size.
In other words, most often, LIHTC rents are not based upon the actual number of members of a household. Instead, the LIHTC program uses hypothetical household sizes based upon bedroom count to select the income figure that is used to set rents. Irrespective of the actual size of the household, LIHTC maximum gross rents are limited based upon a presumed household size of 1.5 occupants per bedroom, or one occupant for studio/bachelor units.
Therefore, to impute household size, multiply the number of bedrooms in a unit by 1.5. For instance, the imputed household size of your four-bedroom units is six. If the imputed household size falls between two whole numbers, calculate the rent based on the average of the income limits for the two whole-number household sizes. And use the one-person household income limit for your studios.
Tip #4: Compare Asset’s Actual Income to Imputed Income When Required
If you determine at a household’s certification or recertification that the household’s assets total $5,000 or less, you must include the actual income those assets generate when you calculate the household’s income [Handbook 4350.3, par. 5-7(E)]. But if a household’s assets total more than $5,000, you must compare the actual income the assets generate with the assets’ imputed income, then count the greater of these two amounts as part of the household’s income [Handbook 4350.3, par. 5-6(F)].
To calculate the imputed income of an asset, multiply its cash value by the percentage rate specified by HUD (currently .06 percent). Compare this result with the annual income the household actually gets from the assets, and use the higher number in calculating the household’s income.