Paul L. Caron

Monday, September 17, 2007

Why Should Congress Bother to Fix the Tax Law It Wrote When It's Easier to Blame the IRS?

Following up on Sunday's post:  Senate Finance Committee Republicans Urge IRS to Lift DOI Income Burden from Homeowners in Foreclosure:

  1. Congress has long required, in § 108, that homeowners report as discharge of indebtedness income the amount of any mortgage debt they are relieved of when they default on their mortgage and the bank forecloses on their home.
  2. The New York Times ran (on August 20) a front page story (After Foreclosure, a Big Tax Bill From the IRS) on a particularly egregious example of the unfairness of taxing strapped homeowners in these circumstances.  In the story, the amount of the income was inflated as a result of an erroneous Form 1099 sent to the taxpayer after a sham foreclosure sale.
  3. Although this has long been the tax result, the problem is particularly acute now with (a) the decline in housing prices, and (b) the sub-prime mortgage mess.
  4. Bills are introduced in Congress (e.g., H.R. 1876, S. 1394) to provide relief in this situation.
  5. The President (on August 31) calls on Congress to change the law to provide relief to homeowners in this situation and endorses these bills.
  6. Rather than do the legislative heavy lifting, Republican on the Senate Finance Committee (Grassley, Smith, and Roberts) send a remarkable letter to the IRS on Friday, urging the IRS to simply ignore the statute that Congress enacted and administratively provide relief to homeowners.
  7. The letter concedes:  "We recognize it would be simpler to change the law
  8. But why do the heavy lifting when it is easier to blame the IRS?:  "Sen. Chuck Grassley, ranking member of the Committee on Finance, along with two fellow Finance Committee members, is urging the Treasury Department and Internal Revenue Service (IRS) to take action to ensure that working families who lose their homes to foreclosure face more reasonable, accurate tax bills for their home loan debt forgiveness. “Working families who lose their homes are getting hit with huge tax bills,” Grassley said. “Some of those bills are unfairly high and even inaccurate. The IRS needs to take steps to ensure the accuracy of the bill in the first place. Then the IRS should offer the taxpayer every opportunity to negotiate the size of the bill and a fair payment plan. The agency has plenty of authority to treat taxpayers reasonably in these situations. It needs to use that authority to serve taxpayers.”
  9. The proposed administrative relief -- at the Offer in Compromise stage -- would take several months for cases to wind their way through the system. Plenty of time to enact a legislative fix.
  10. But of course, a legislative fix would require revenue offsets under Congressional budget rules.  Not so with administrative action by the IRS.

(Hat Tip:  Ann Murphy, Mike McIntyre.)  For a critical view of the proposed §108 fix, see The Heritage Foundation: The Subprime Mortgage Crunch: Providing Tax Relief for Ex-Homeowners, by JD Foster:

The Administration's tax proposal, while well intentioned, is nevertheless misguided and all the more unfortunate because the Administration missed an opportunity to provide tax relief through sound tax reform. ...

A sound and sensible means to reduce the bite of the federal income tax on families who have recently lost their homes to foreclosure is to correct the tax treatment of cancelled mortgage debt. The current treatment as taxable income violates normal income tax principles. The correct treatment would be as capital gain and, in almost all instances, long-term capital gain. If additional tax relief for these families is deemed appropriate, Congress can allow them to delay, for a year or two, payment of the tax on the capital gain.

Update:  For more, see:

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A couple of points - 1) the 1099's typically overstate the amount of debt forgiveness, incorrectly including unpaid interest, 2) section 108 income is only taxable to the extent the taxpayer is solvent - most individuals being foreclosed on are not solvent or just marginally solvent after the transaction. 3) the last point mentioned above, is that is inequitable to treat similar situated taxpayers differently -for example, loss on the sale of the home is non deductible loss, the gain is excluded under setion 121 - in a foreclosure situation you typically have loss on the foreclosure and income from debt discharge

Posted by: joe | Sep 17, 2007 8:40:42 AM

If the homeowner cannot pay his mortgage, how stupid
to assume the homeowner can pay a huge tax bill.
And it is outrageous to instruct an iRS agent/s to
obstruct or break standing law.
The whole scheme is disgusting and demoralizing.

Where is the law/s written the tax payer must pay taxes
on the labors of his body. Doesn't that make american
citizens indentured servants to the federal government?

Posted by: M.Whitton | Sep 17, 2007 8:03:21 AM

Isn't the appropriate "fix" fairly simple? COD income from a home mortgage is treated as a partial sale of the house, elgible for the Section 121 exclusion. Why should we treat home owners who loose value differently than home owners who sell in the money?

Posted by: Think38 | Sep 17, 2007 7:28:21 AM