BILL ANALYSIS Ó
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|SENATE RULES COMMITTEE | AB 1393|
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THIRD READING
Bill No: AB 1393
Author: Perea (D), et al.
Amended: 6/15/14 in Senate
Vote: 27 - Urgency
PRIOR VOTES NOT RELEVANT
SENATE GOVERNANCE & FINANCE COMMITTEE : 5-0, 5/14/14
AYES: Wolk, DeSaulnier, Hernandez, Liu, Walters
NO VOTE RECORDED: Knight, Beall
SENATE APPROPRIATIONS COMMITTEE : 7-0, 6/23/14
AYES: De León, Walters, Gaines, Hill, Lara, Padilla, Steinberg
SUBJECT : Personal income taxes: income exclusion: mortgage
debt forgiveness
SOURCE : California Bankers Association
DIGEST : This bill extends Californias modified conformity to
the Mortgage Forgiveness Debt Relief Act for discharges of
qualified principal residence indebtedness until January 1,
2014.
ANALYSIS : California law does not automatically conform to
changes to federal tax law, except for specific retirement
provisions. Instead, the Legislature must affirmatively conform
to federal changes. Conformity legislation is introduced either
as individual tax bills to conform to specific federal changes,
like the Regulated Investment Company Modernization Act (AB
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AB 1393
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1423, Perea, Chapter 490, Statutes of 2011), or as one omnibus
bill that provides that state law conforms to federal law as of
a specified date, currently January 1, 2009 (SB 401, Wolk,
Chapter 14, Statutes of 2010).
In 2007, Congress enacted the Mortgage Forgiveness Debt Relief
Act of 2007 (MFDRA), which provides that taxpayers may exclude
from income qualified principal residence indebtedness cancelled
after January 1, 2007 but before January 1, 2010. Married
taxpayers may exclude up to $2 million in qualified principal
residence indebtedness, while married persons filing separate or
single persons may exclude up to $1 million. Taxpayers may only
exclude indebtedness incurred to purchase, construct, or improve
the taxpayer's principal residence, defined as the residence
that the taxpayer owns and uses as his or her principal
residence for at least two out of the last five years. The
Emergency Economic Stabilization Act of 2008 extended the
exclusion until January 1, 2013. On January 2, 2013, Congress
enacted the American Taxpayer Relief Act of 2012, which extended
the exclusion for the 2013 taxable year.
This bill extends California's modified conformity to the
Mortgage Forgiveness Debt Relief Act for the discharge
indebtedness for related penalties and interest of qualified
principal residence indebtedness that occur beginning January 1,
2013 until January 1, 2014.
Background
When a lender cancels a borrower's debt, federal and state law
generally treats the amount of debt cancelled as income taxable
to the borrower. Taxpayers do not include borrowed funds in
income in the year he/she receives loan proceeds because of the
obligation to repay the loan; the taxpayer is financially no
better off because the loan must be repaid. When lenders reduce
the repayable amount, the taxpayer realizes a gain in his or her
financial situation because a portion of the loan proceeds
already received and not previously taxed need not be repaid.
In U.S .v. Kirby Lumber Co., 284 US 1 (1931), the U.S. Supreme
Court held that a company that had issued $12 million in bonds
and later repurchased some of them at less than their face
amount made a clear gain which should be treated as income to
the taxpayer. Congress subsequently deemed cancelled debt as
income, with exceptions for:
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Debts discharged in bankruptcy
When the taxpayer is insolvent, debt discharge is excluded up
to the amount of the insolvency, but triggers specified basis
adjustments,
Certain farm debts, and
Debt discharge resulting from a non-recourse loan in
foreclosure.
Many Californians experienced rapid declines in the market
values of their homes in recent years, so much so that the value
was less than the amount of debt they incurred to buy it. Some
homeowners have sufficient income, equity, and home value to
refinance, but others cannot, and instead attempt to sell their
home for less than they are obligated to repay their lender,
which is known as a "short-sale." Instead of a simple
transaction between buyer and seller, a short sale requires a
third party - the seller's lender - to agree to cancel the
borrower's debt in an amount equal to the difference between the
new sales price of the home and the original amount of the debt
issued to the borrower to buy it, plus any additional debt
secured by the property. For example, a lender must cancel
$150,000 in debt for a borrower who purchased a home in 2005 for
$400,000, but wants to short sell it this year for $250,000.
The lender must assess the current housing market, the current
borrower's ability to repay the loan, and federal and state
incentives when considering whether to accept this loss. While
lenders can claim principal forgiven as a deductible business
loss, the borrower faces a significant tax bill in addition to
the loss of any equity in the home at the time of sale absent
legislation. Additionally, any loan modification where the
lender forgives principal as part of a loan modification, a
deed-in-lieu of foreclosure, or a foreclosure usually results in
taxable income for the borrower.
California first conformed to MFDRA in 2008, and again in 2010,
for debt discharged on or before December 31, 2012, with the
following differences:
Taxpayers may only exclude up to $250,000 single/ $500,000
joint of cancelled debt from income.
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Taxpayers may only exclude indebtedness on loans up to
$400,000 single/$800,000 joint of qualified principal
residence indebtedness. The taxpayer must first reduce any
amount excluded for state tax purposes by any debt forgiven on
loan amounts above $400,000/$800,000.
Mortgage debt relief only applies to recourse loans, not
non-recourse ones. A loan is non-recourse when the lender can
only repossess the asset that secures the loan to satisfy
delinquent debt; a recourse loan allows a lender to petition a
court for a personal deficiency judgment against a delinquent
borrower, a public record that allows the lender to collect the
delinquent amount from the borrower in a variety of ways. In
California, all original loans to purchase homes in the state
must be nonrecourse, but the status often changes to recourse
when the home is refinanced, or the borrower takes out a second
mortgage or a home equity line of credit.
In 2010, the Legislature prohibited a lender from obtaining a
deficiency judgment for any first mortgage deficiency after a
short sale of a residence. In 2011, the Legislature extended
that treatment for all residential mortgages, including second
mortgages after a short sale. Soon after, tax scholars argued
that the Legislature's action on deficiency judgments
essentially converted recourse mortgage debt from a short sale
to non-recourse debt.
The Internal Revenue Service (IRS) wrote to Senator Barbara
Boxer in December, 2013 indicating its belief that the
Legislature's action to bar lenders from issuing deficiency
judgments to satisfy recourse debts changes the debt to
non-recourse in short sales, therefore taxpayers should not
include the income for California purposes. IRS's letter did
not address loan modifications that result in principal
forgiveness, deeds-in-lieu of foreclosure, or foreclosures.
FISCAL EFFECT : Appropriation: Yes Fiscal Com.: Yes
Local: No
According to the Senate Appropriations Committee, the Franchise
Tax Board estimates that this bill results in General Fund
revenue losses of $35 million in 2013-14, and $4 million in
2014-15.
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SUPPORT : (Verified 6/23/14)
California Bankers Association (source)
Board of Equalization Member, George Runner
California Association of Realtors
California Credit Union League
California Independent Bankers
California Society of Enrolled Agents
CalTax
ARGUMENTS IN SUPPORT : According to the author, "AB 1393 would
extend the tax relief on forgiveness of mortgage debt by
conforming California law to federal law.
"An unemployment rate over 10% has persisted for years and has
left many Californians without the resources to sustain their
mortgages, while the mortgage crisis has left many homeowners
'underwater' on their property investment. After foreclosure,
mortgage refinancing, or a short sale of a home, a bank can
cancel or forgive thousands of dollars of an individual's
mortgage debt. Federal and State income tax law generally
defines cancelled debt as a form of income. Without additional
legislation to exclude cancelled debt, many Californians will be
taxed on 'income' that they never received."
AB:k:n 6/24/14 Senate Floor Analyses
SUPPORT/OPPOSITION: SEE ABOVE
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