BILL ANALYSIS �
SB 30
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Date of Hearing: August 12, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
SB 30 (Ron Calderon) - As Amended: May 30, 2013
2/3 vote. Urgency. Fiscal committee.
SENATE VOTE : 36-0
SUBJECT : Taxation: cancellation of indebtedness: mortgage
debt forgiveness
SUMMARY : Extends California's modified conformity to the
mortgage Debt Forgiveness Act for discharges of qualified
principal residence indebtedness (QPRI) for one additional
taxable year. Specifically, this bill :
1)Substitutes the phrase "January 1, 2014" for the phrase
"January 1, 2013" in Internal Revenue Code (IRC) section
108(a)(1)(E).
2)Applies to discharges of QPRI occurring on or after January 1,
2013.
3)Provides that this act shall become operative only if Senate
Bill 391 of the 2013-14 Regular Session is enacted and takes
effect.
4)Takes effect immediately as an urgency statute.
EXISTING FEDERAL LAW :
1)Includes in gross income of a taxpayer an amount of debt that
is discharged by the lender, except for any of the following:
a) Debts discharged in bankruptcy;
b) Some or all of the discharged debts of an insolvent
taxpayer. A taxpayer is insolvent when the amount of the
taxpayer's total debt exceeds the fair market value of the
taxpayer's total assets;
c) Certain farm debts and student loans; or,
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d) Debt discharged resulting from a non-recourse loan in
foreclosure. A non-recourse loan is a loan for which the
lender's only remedy in case of default is to repossess the
property being financed or used as collateral. (IRC
Section 108).
2)Requires a taxpayer to reduce certain tax attributes by the
amount of the discharged indebtedness in the case where the
indebtedness is excluded from the taxpayer's gross income.
(IRC Section 108)
3)Excludes from a taxpayer's gross income cancellation of
indebtedness (COD) income that resulted from the discharge of
QPRI occurring on or after January 1, 2007, and before January
1, 2014.
4)Defines "QPRI" as acquisition indebtedness within the meaning
of IRC Section 163(h)(3)(B), which generally means
indebtedness incurred in the acquisition, construction or
substantial improvement of the principal residence of the
individual and secured by the residence. "QPRI" also includes
refinancing of such debt to the extent that the amount of the
refinancing does not exceed the amount of the indebtedness
being refinanced.
5)Allows married taxpayers to exclude from gross income up to $2
million in QPRI (married persons filing separately may exclude
up to $1 million of the amount of that indebtedness). For all
taxpayers, the amount of discharge of indebtedness generally
is equal to the difference between the adjusted issue price of
the debt being cancelled and the amount used to satisfy the
debt. For example, if a creditor forecloses on a home owned
by a solvent taxpayer and sells it for $180,000 but the house
was subject to a $200,000 mortgage debt, then the taxpayer
would have $20,000 of income from the COD.
6)Specifies that if, immediately before the discharge, only a
portion of a discharged indebtedness is QPRI, then the
exclusion applies only to so much of the amount discharged as
it exceeds the port of the debt that is not QPRI. For
example, a taxpayer's principal residence is secured by an
indebtedness of $1 million, of which only $800,000 is QPRI.
If the residence is sold for $700,000 and $300,000 debt is
forgiven by the lender, then only $100,000 of the COD income
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may be excluded under IRC Section 108.
7)Defines the term "principal residence" pursuant to IRC Section
121 and the applicable regulations.
8)Excludes from tax a gain from the sale or exchange of the
taxpayer's principal residence if, during the five-year period
ending on the date of the sale or exchange, the property has
been owned and used by the taxpayer as his/her principal
residence for periods aggregating two year or more. The
amount of gain eligible for the exclusion is $250,000
(taxpayers filing single) or a $500,000 (for married taxpayers
filing a joint return).
9)Requires a taxpayer to reduce the basis in the principal
residence by the amount of the excluded COD income.
EXISTING STATE LAW :
1)Conforms to the federal income tax law relating to the
exclusion of the discharged QPRI from the taxpayer's gross
income, with the following modifications:
a) Applies to the discharge of indebtedness occurring on or
after January 1, 2007 and before January 1, 2013.
b) The maximum amount of QPRI is limited to $800,000
($400,000 for married/RDP filing separate).
c) For discharges occurring in 2007 or 2008, the total
amount of non-taxable COD income is limited to $250,000
($125,000 in the case of a married /RDP individual filing a
separate return).
d) For discharges occurring on or after January 1, 2009,
and before January 1, 2013, the maximum cancellation of
debt income exclusion is $500,000 ($250,000 for married/RDP
filing separate).
e) Requires individual taxpayers to pay their estimated
California income tax in four installments over the taxable
year. Imposes a penalty for the underpayment of estimated
tax, which is the difference between the amount of tax
shown on the return for the taxable year and the amount of
estimated tax paid. However, no underpayment penalty or
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interest is assessed for the 2009 tax year.
FISCAL EFFECT : The Franchise Tax Board (FTB) estimates an
annual revenue loss of $50 million in fiscal year (FY) 2013-14,
and $5 million in FY 2014-15.
COMMENTS :
1)The author states that "SB 30 is a federal tax conformity bill
that extends the sunset date on an important piece of
legislation that has lapsed at the end of the 2012 year?
Homeowners currently in short sale negotiations cannot
finalize transactions without potentially incurring a tax they
already cannot afford. Yet they do not have the luxury of
time to wait to see if the state will act to provide relief
from this tax." According to the author, "if a lender agrees
to forgive some of a borrower's mortgage debt[,] that forgiven
debt is taxed as ordinary income in the year which the [debt]
is forgiven." "SB 30 will provide immediate tax relief to
Californians upon its enactment." Lastly, the author states
that "SB 30 is the right thing to do. Families forced to make
the difficult decision to sell their home as a short sale are
already in financial trouble. They simply cannot afford to
pay an additional tax on money they have never actually
received."
2)Supporters of this measure state that "SB 30 would allow the
state to continue exempting homeowners from paying state
income taxes on the loan amount written down on their
principal residence through a principal reduction or
short-sale? Continuing this exemption on income the homeowners
never realizes, is sound public policy and will allow
struggling homeowners to get back on their feet and continue
generating economic activity."
3)Mortgage Debt Forgiveness: Background : In 2008, the
Legislature approved SB 1055 (Machado), Chapter 282, which
provided modified conformity to the Mortgage Forgiveness Debt
Relief Act (MFDRA) for discharge of mortgage indebtedness in
2007 and 2008 tax years. In 2010, the Legislature enacted SB
401 (Wolk), Chapter 14, to provide homeowners even greater
assistance. It not only extended the mortgage debt
forgiveness provision until January 1, 2013, but also
increased the amount of forgiven mortgage indebtedness
excludable from taxpayer's gross income from $250,000
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($125,000 in case of married individual/RDP filing separate
return) to $500,000 ($250,000 in case of married
individual/RDP filing a separate return). On January 2, 2013,
the federal government enacted FATRA as part of the fiscal
cliff deal. FATRA extended the exclusion from gross income
for COD generated from the discharge of QPRI, as provided for
by the MFDRA, for one additional taxable year, beginning on or
after January 1, 2013.
4)Why is COD Taxable? : Most individuals find the idea of taxing
debt cancellation counter intuitive, but the practice reflects
sound tax policy because it recognizes the fact that an
individual's net worth has increased by the cancellation of
debt. According to Commissioner v. Glenshaw, the Court
defined income as an accession to wealth, that is clearly
realized, and over which the taxpayer has complete
dominion<1>. When debt is cancelled, money that would have
been used to pay that loan is now free to be used on whatever
the taxpayer wants. Therefore, because certain assets have
been freed, the taxpayer has experienced an accession to
wealth. Additionally, under the rule of symmetry, a loan is
not considered income to the borrower nor is it a deduction to
the lender. A borrower's increased wealth when the loan is
incurred is offset by the obligation to pay the same amount.
If the debt is cancelled, the symmetry is destroyed and the
borrower is in a much better financial position. As noted by
Debora A. Grier, Professor of Law of Cleveland State
University, in her statement before the United State Senate
Committee on Finance, without this tax rule, "the borrower
will have received permanently tax-free cash in the year of
the original receipt," i.e. the year in which the borrower
received the loan. Even understanding the economic and legal
policy for taxing COD, most individuals still find the
taxation of cancelled home mortgage debt odd and even unfair.
5)Non-Recourse Debt : Non-recourse debt is a loan that is
secured by the pledge of collateral. If the borrower
defaults, the lender can seize the collateral, but the
recovery is limited to the collateral. In California,
indebtedness incurred in purchasing a home is deemed to be
non-recourse debt (Code of Civil Procedure Section 580b) and
thus, generally, first mortgages are considered to be
non-recourse debt. Property that is foreclosed upon is not
---------------------------
<1> Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
(1955).
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considered COD, even if the amount of the loan exceeds the
fair market value (FMV) of the property. However, if a lender
agrees to decrease the amount of the original debt to reflect
the current value of the property secured by the debt, the
transaction will be considered COD and subject to tax. This
is because the cancellation of non-recourse debt without a
transfer of property creates COD income for the taxpayer in an
amount equal to the amount cancelled by the lender.
California law provides relief to a solvent homeowner who
refinanced the first mortgage or took out a home equity loan
or a home equity line of credit. It provides relief to a
solvent homeowner who benefited from a reduction of his/her
outstanding debt in a "workout" situation with the lender
where the homeowner retained the ownership of the home and the
lender, instead of foreclosing on the home, reduced the
outstanding debt to reflect the home's current value.
6)Insolvency : COD is not included in income to the extent the
taxpayer is insolvent immediately before the debt is
cancelled. A taxpayer is insolvent immediately before the COD
to the extent that the amount of total liabilities exceeds the
FMV of all assets immediately before the cancellation. This
provision may be used in lieu of the qualified principal
residence indebtedness exclusion. It is important to
remember, however, that the exclusion applies only to the
extent of insolvency. As an example, assume a taxpayer has
discharged debt of $5,000. Before the cancellation of debt,
the taxpayer had $10,000 in liabilities and the FMV of all
assets was $7,000. This means that before the cancellation,
the taxpayer was insolvent to the extent of $3,000 dollars
(total liabilities minus FMV assets). Therefore, the taxpayer
may exclude $3,000 from income and include $2,000 as income of
the discharged debt.
7)Why exclude COD from Gross Income? : Despite the economics of
taxing COD, the rationale for excluding cancelled mortgage
from gross income has focused on minimizing hardship for
households in distress. Individuals who are in danger of
losing their homes, due in part to the economic downturn,
should not be forced to incur the additional hardship of
paying taxes on COD. It also reduces the burden on a borrower
who may be attempting to write-down the loan with their lender
or a short sale. On a macroeconomic level, economists have
argued that excluding cancelled mortgage from gross income may
help maintain consumer spending, which may help prevent a
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recession.
As noted earlier, one of rationales for excluding mortgage
forgiveness from income is to help taxpayers remain in their
home. In some instances, a lender may be able to reduce the
loan amount to the home's current FMV and allow the taxpayer
to retain ownership of the home. For example, a taxpayer may
owe $250,000 of residential debt, and after a modification,
the lender reduces the loan down to $200,000 and forgives
$50,000. Without an exclusion of the mortgage cancellation,
the $50,000 would be subject to taxation. If the taxpayer is
subject to a 25% tax rate, the tax liability would be $12,500.
Assuming the reduction in loan was done because the taxpayer
was facing financial difficulty, incurring a tax obligation on
COD may prevent the taxpayer from successfully remaining in
the home. [See, Congressional Research Service's report (CRS
report) entitled analysis of the Proposed Tax Exclusion for
Cancelled Mortgage Debt Income, dated January 8, 2008, 2 -8].
8)QPRI Includes Secondary Loans : The exclusion for COD income
realized by the taxpayer from the COD applies as long as the
discharged debt was secured by a personal residence and was
incurred to acquire, construct, or substantially improve the
home, as well as debt that was used to refinance such debt.
Debt on second homes, rental property, business property,
credit cards, or car loans does not qualify for the tax-relief
provision. However, the definition of QPRI includes second
mortgages, home equity loans, and home equity lines of credit
used to improve the residence. Yet, home equity lines of
credit could have also been used to finance consumption.
Thus, existing law provides a financial incentive for
taxpayers to claim the COD income exclusion for secondary
loans even if the proceeds of those loans were used for
personal consumption.
9)Contingent Enactment Language : This bill is contingent upon
the enactment of SB 391 (DeSaulnier, 2013), which imposes a
fee of $75 on the recording of each real estate-related
document, except for those documents recorded in connection
with a transfer subject to a documentary transfer tax, and
directs the money to the California Homes and Jobs Trust Fund
(Trust Fund).
10)Suggested technical amendments :
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Amendment 1
On page 2, on line 4, strike out "as follows:", and strike out
lines 5 through 9, inclusive, and insert:
to provide that the amount excluded from gross income shall
not exceed $500,000 ($250,000 in the case of a married
individual filing a separate return).
Amendment 2
On page 2, between lines 16 and 17, insert:
(c) The amendments made by Section 202 of the American
Taxpayer Relief Act of 2012 (Public Law 112-240) to Section
108 of the Internal Revenue Code shall apply.
Amendment 3
On page 2, line 17, strike out "(c)" and insert:
(d)
Amendment 4
On page 2, line 24, strike out "(d)" and insert:
(e)
11)Related Legislation .
AB 42 (Perea), introduced in the current legislative session,
would extend the tax relief for income generated from the
discharge of qualified principal residence indebtedness, in
modified conformity to federal law, for one additional taxable
year. AB 42 was held in the Assembly Committee on
Appropriations.
AB 856 (Jeffries), introduced in the 2011-12 legislative
session, would have conformed fully to the Mortgage
Forgiveness Debt Relief Act (MFDRA) as extended by the
Emergency Economic Stabilization Act (ESSA) to discharged debt
occurring on or after January 1, 2010, and before January 1,
2013. AB 856 was held by this Committee.
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AB 111 (Niello), introduced in the 2009-10 legislative
session, would have provided the same exclusion from gross
income for mortgage forgiveness debt relief that is allowed
under federal law for discharges occurring on or after January
1, 2007, and before January 1, 2013. AB 111 was held by this
Committee.
SB 401 (Wolk), Chapter 14, Statutes of 2010, amended the PIT
Law to conform to the federal extension of mortgage
forgiveness debt relief provided in the Emergency Economic
Stability Act, with the following modifications: (a) it
applies to discharges occurring in 2009, 2010, 2011, and 2012
tax years, (b) the total amount of QPRI is limited to $800,000
($400,000 in the case of a married individual or domestic
registered partner filing a separate return; (c) the total
amount excludable is limited to $500,000 ($250,000 in the case
of a married individual or domestic registered partner filing
a separate return); and (d) interest and penalties are not
imposed with respect to discharges that occurred in the 2009
taxable year.
AB 1580 (Calderon), introduced in the 2009-2010 legislative
session, was similar to SB 401 (Wolk). AB 1580 was vetoed by
the governor.
SB 97 (Calderon), introduced in the 2009-10 legislative
session, extended the provisions of PIT Law to allow a
taxpayer to exclude from his/her gross income the COD income
generated from the discharge of QPRI in 2009, 2010, 2011, or
2012 tax year. SB 97 never moved off the Senate Revenue &
Taxation Committee suspense file.
SB 1055 (Machado), Chapter 282, Statutes of 2008, amended the
PIT Law to conform to the federal Act of 2007, except that it
imposed certain limitations on the amount of QPRI and COD
income eligible for the exclusion. SB 1055 specified that the
exclusion applied to a discharge of QPRI that occurred in the
2007 and 2008 taxable years.
AB 1918 (Niello), introduced in the 2007-08 legislative
session, was similar to SB 1055. AB 1918 modified federal law
to allow the exclusion for up to $1 million/$500,000 of QPRI
and did not impose any limitations on the amount of COD
income. AB 1918 was held in this Committee.
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REGISTERED SUPPORT / OPPOSITION :
Support
California Association of Realtors
California Bankers Association
California Credit Union League
California Independent Bankers
Department of Justice, State of California
Opposition
None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098