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Owners should use due diligence by asking follow-up questions when the income certification process reveals unusual circumstances suggesting additional sources of income.

Written by Lainey Nadeau, Spectrum Enterprises

This quote is from the IRS 8823 guide, Chapter 4 pg. 4-33. Chapter 4 deals with Category 11a of the 8823 form. This category is used to report units rented to households with incomes that exceed the income limit at initial occupancy. I find myself using this quote often when reviewing files for compliance because exhibiting due diligence and recognizing unusual circumstances is an essential part of the LIHTC program.

Owners should use due diligence… What is due diligence? Here is the 8823 guide definition as found in the footnote on pg. 4-15:

Due diligence is defined (Black’s Law Dictionary [6th ed.1990]) as: “Such measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person under the particular circumstances; not measured by any absolute standard, but depending upon the relative facts of the special case.” In short, the due diligence standard is a judicially created test to determine the adequacy of the efforts exerted throughout all phases of any activity.

Got it? Let’s break it down. A reasonable and prudent person under the particular circumstance. This would likely be the owner/manager/staff person responsible for reviewing the application, obtaining third party verification, reviewing tenant submitted documents, obtaining clarifications and determining anticipated income. Under the particular circumstance means this person is expected to understand the LIHTC program. The owner should also be familiar with the expectations of their state’s housing finance agency (HFA) and the property’s investor. For example, the HFA may require the use of certain HFA forms, such as the TIC, application, employment verification, etc. To find the requirements in your state visit your HFA’s Web site. You can find a link to each HFA Web site at http://lihtc.huduser.org/agency_list.htm.

…not measured by any absolute standard, but depending upon the relative facts of the special case. Not all situations/files are the same. Obtaining a third party employment verification may be enough to determine income in one file while another file may require pay stubs, tax returns or telephone clarification in addition to the third party employment verification. The owner needs to be able to recognize when additional efforts are required to adequately determine income. For example an owner should obtain additional verification when a household’s income is close to the income limit, when a household member’s employment is seasonal or sporadic, or when a household claims zero income.

…adequacy of the efforts exerted throughout all phases of any activity. Due diligence must be exhibited in every stage of the LIHTC process. For example, the owner should ensure that the application, questionnaire, verification forms etc. ask the appropriate questions to gather all relevant information, including household composition, income, assets, and student status. In addition, when the owner reviews the tenant application, verification forms etc. she should check that all forms are complete and information is consistent. When questions arise additional information should be obtained and a clarification record should be in the file. When calculating income the owner should consider a variety of methods, such as calculating income based on YTD earnings in addition to straight calculation.

Example: ABC property verifies an applicant’s student status using a Student Status Affidavit and by a question on the application. Both the affidavit and the application ask the applicant if he is currently a full time or part time student and/or does he anticipate enrolling as a full time or part time student in the next 12 months. Using these verification methods does not exhibit an “adequacy of efforts” because the applicant is only questioned about current and future student status. To be eligible for the LIHTC program the applicant must also be questioned about their previous student status during any 5 months of the taxpayer’s calendar year.

Example: The owner receives employment verification (EV) where the number of hours worked per week has been crossed out and a different number written next to it. The owner can exhibit due diligence by following up with the employer and to ask why information was crossed out on the EV. A clarification record would be placed in the file stating the reason for the change. The clarification record must document the third party’s name, position and contact info; the information obtained from the third party; the name of the person who conducted the clarification and the date and time of the call (HUD Handbook 4350.3, p. 5-60-61).

Example: The head of household (HOH) listed herself and a friend as occupants on the application however the only occupant listed on the TIC is the HOH. Due diligence is exhibited in the file because the HOH completed a clarification record stating that after completing the application her friend moved out of state. The use of clarification records to explain discrepancies in the file shows that the owner understands the LIHTC program and what is adequate to demonstrate compliance.

…Owners should use due diligence by asking follow-up questions… The 8823 guide says “acceptable methods of verifying information include third party verifications, reviews of documents submitted by the tenant (such as check stubs), and tenant certifications made under penalties of perjury” (p. 4-7). Third party verification may be written or obtained through a telephone conversation with a third party contact. Written third party verification may be sent through the mail or obtained via fax, email or the Internet. Additional information regarding verification methods can be found in the HUD Handbook 4350.3.

It is often by reviewing third party documents that the need for follow up questions arises, either because the document is incomplete, or because it contradicts other information in the file. Here are some examples:

Example: Written third party EV lists an over-time (OT) rate of pay of $12/hour however the question of how many OT hours worked per week was left blank. The owner can exhibit due diligence by conducting a telephone follow up with the person who filled out the EV to determine the # of OT hours worked per week. The owner should never assume that a blank on a form means none/not applicable.

Example: Written third party employment verification lists the applicant’s regular wage of $10/hr and states he works 40 hrs/wk. The EV is filled out in its entirety and no other sources of income are stated. The applicant’s annual income based on the EV is $20,800 ($10x40x52). However, the owner sees that the applicant listed his annual income from this job as $24,000 on the application. The owner can exhibit due diligence in a number of ways. She could perform a telephone clarification with applicant and/or with the person who completed the EV or she could request additional documents from the applicant. In this case requesting a series of recent consecutive paystubs from the applicant may give a better indication of income. When requesting pay stubs the HUD 4350.3 says to, “require most recent 6-8 consecutive pay stubs; do not use check without stub” (Appendix 3, p. 8). The owner could also request the applicants previous year(s) tax return.

Example: An applicant lists the composition of her household as herself and her two minor children on the application. She is self-employed and provides her previous two years tax returns to verify her self-employment income. While the owner is reviewing her tax return he notices that no dependants are listed. The household is income eligible using the three person income limit but the applicant is not eligible using the one person income limit. The owner can exhibit due diligence by performing a telephone clarification with the applicant to ask about the dependant status of her children. He should also request proof of custody. The 8823 guide says to include children in family size who are “present in the household 50% or more of the time. If disputed, determine which parent claimed the children as dependents for purposes of filing a federal income tax return” (p. 4-3). Since the children are not listed as dependants on her tax return additional documentation is required.

Owners should use due diligence by asking follow-up questions when the income certification process reveals unusual circumstances suggesting additional sources of income.

As mentioned earlier not all files or situations are the same. Sometimes reviewing documents or speaking with the applicant is going to suggest that something isn’t adding up and that there may be additional sources of income. The owner needs to be able to recognize these unusual circumstances and exercise due diligence. Here are some examples of unusual circumstances:

Example: On the application and Asset Addendum the applicant does not list any real estate as an asset. As part of the property’s tenant selection criteria the owner obtains a credit report on each adult applicant. The credit report shows what appears to be a current mortgage. Looking back at the application the owner notices that the applicant did not list a current landlord or current rent amount. It appears that the applicant may own a home. Additional sources of income could be income from the asset or rental income. The owner can exhibit due diligence by performing a telephone clarification with the applicant and obtaining third party verification from the mortgage company, from the city property assessor, etc.

Example: An applicant claims to have zero income. She completed an Unemployed Affidavit and stated she does not anticipate working in the next 12 months. She completed a Zero Income Certification and stated she will be paying her rent, utility allowance and living expenses using her Section 8 voucher. The owner recognizes that her Section 8 voucher may pay her rent and provide her with a utility reimbursement to pay her utilities, however the voucher does not pay for her other living expenses. The owner notices that on the application the tenant listed a cell phone number and a vehicle. This suggests additional sources of income. The owner can exhibit due diligence by performing a telephone clarification with the applicant to determine how she pays for food, clothing, cell phone, gasoline, car payment, insurance etc. Remember, the 8823 guide states, “regular, recurring monetary and nonmonetary gifts or contributions to residents from persons not living in the unit must be included in income. This can include the payments of bills on behalf of a resident” (p. 4-18). If the applicant receives gifts or contributions (except for groceries) the owner should obtain third party verification from the source of the contribution.

Example: Two adults apply for an apartment on 2/8/12. The 2 person income limit is $32,000. She is employed earning $28,000 a year. He claims zero income. On the Unemployed Affidavit he says he does not expect to become employed in the next 12 months. He says his previous employment ended on 1/6/12. On the Zero Income Certification he states that his roommate will be paying the rent, utilities and his living expenses. The owner should recognize that this is an unusual circumstance. He was recently employed. The owner should follow up with the applicant to determine why he does not anticipate returning to work. The 8823 guide states that when someone “reports little or zero income, or sporadic income, owners may use estimates based on actual income earned or received during the twelve month period immediately preceding the certification” (p.4-33). The owner should obtain third party verification of his previous employment. The owner should verify if this employment was seasonal or sporadic. The owner should question if he expects to receive unemployment benefits. If he started working the HH could easily be over income. Due diligence must be exhibited.

Using a good application form and verification forms is critical. Just as critical is making sure that the owner/manager/or staff person reviewing the documents and calculating income understands the LIHTC program. Due diligence is demonstrated when all documents in a file are complete and/or the file contains a clarification record whenever They also need to understand the concept and meaning of due diligence, recognize unusual circumstances and know the appropriate way to follow up when unusual circumstances arise. With those things in place your property can avoid an 8823 Category 11a finding.

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