BILL ANALYSIS                                                                                                                                                                                                    Ó






                                                                        AB 99


                                                                       Page A


          ASSEMBLY THIRD READING


          AB  
          99 (Perea)


          As Amended  May 20, 2015


          2/3 vote. Urgency


           ------------------------------------------------------------------- 
          |Committee       |Votes |Ayes                |Noes                  |
          |                |      |                    |                      |
          |                |      |                    |                      |
          |----------------+------+--------------------+----------------------|
          |Revenue &       |9-0   |Ting, Brough,       |                      |
          |Taxation        |      |Dababneh, Gipson,   |                      |
          |                |      |Roger Hernández,    |                      |
          |                |      |Mullin, Patterson,  |                      |
          |                |      |Quirk, Wagner       |                      |
          |                |      |                    |                      |
          |----------------+------+--------------------+----------------------|
          |Appropriations  |17-0  |Gomez, Bigelow,     |                      |
          |                |      |Bonta, Calderon,    |                      |
          |                |      |Chang, Daly,        |                      |
          |                |      |Eggman, Gallagher,  |                      |
          |                |      |                    |                      |
          |                |      |                    |                      |
          |                |      |Eduardo Garcia,     |                      |
          |                |      |Gordon, Holden,     |                      |
          |                |      |Jones, Quirk,       |                      |
          |                |      |Rendon, Wagner,     |                      |
          |                |      |Weber, Wood         |                      |
          |                |      |                    |                      |
          |                |      |                    |                      |
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                                                                        AB 99


                                                                       Page B




          SUMMARY:  Extends for one additional taxable year, in modified  
          conformity to the recently enacted federal law, the tax relief for  
          income generated from the discharge of qualified principal  
          residence indebtedness (QPRI).  Specifically, this bill:  


          1)Provides that Internal Revenue Code (IRC) Section 108, relating  
            to income from discharge of QPRI, as amended by Tax Increase  
            Prevention Act of 2014 Section 102, shall apply, except as  
            otherwise provided.
          2)Applies discharges to QPRI occurring on or after January 1,  
            2014, and before January 1, 2015.


          3)Provides that, notwithstanding any other law, no penalties or  
            interest shall apply be due to the discharge of QPRI for the  
            2014 taxable year, regardless of whether or not a taxpayer  
            reports the discharge during the 2014 taxable year.


          4)Makes findings and declarations stating that the retroactive  
            application of this bill is necessary for the public purpose of  
            conforming to federal law, and thereby preventing undue hardship  
            to taxpayers whose QPRI was discharged on and after January 1,  
            2014, and before January 1, 2015, and does not constitute a gift  
            of public funds.


          5)Provide that this is an urgency statute necessary for the  
            immediate preservation of the public peace, health, or safety.


          FISCAL EFFECT:  According to the Assembly Appropriations  
          Committee:


          1)Minor and absorbable administrative costs to the Franchise Tax  











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          Board.


          2)Estimated General Fund revenue decreases of $47 million and $5  
            million in Fiscal Year 2014-15 and Fiscal Year 2015-16,  
            respectively.  No estimated revenue impact thereafter.


          COMMENTS:  


          1)Author's Statement:  The author provided the following statement  
            in support of this bill:


               AB 99 would extend the tax relief on forgiveness of  
               mortgage debt by conforming California law to  
               federal law.  After a loan modification or 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 laws generally  
               define cancelled debt as a form of income.  Without  
               additional legislation to exclude cancelled debt,  
               many Californians may be taxed on "phantom" income  
               they never received.


          2)Arguments in Support:  Proponents of this bill state that "when  
            debt is forgiven by a lender as part of an agreement with a  
            borrower using the short sale process or a principal reduction,  
            the borrower should not be penalized on their state income  
            taxes.  Many borrowers who faced foreclosure last year and  
            successfully negotiated a loan modification may well find  
            themselves once again unable to make their mortgage payment if  
            they are saddled with a tax burden resulting from forgiven  
            debt." 
          3)Arguments in Opposition:  None submitted.













                                                                        AB 99


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          4)Mortgage Debt Forgiveness: Background.  SB 1055 (Machado),  
            Chapter 282, Statues of 2008, provided modified conformity to  
            the Mortgage Forgiveness Debt Relief Act (MFDRA) for discharge  
            of mortgage indebtedness in 2007 and 2008 tax years.  SB 401  
            (Wolk), Chapter 14, Statues of 2010, provided homeowners even  
            greater assistance.  SB 401 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 ($125,000 in case of  
            married individual/registered domestic partners (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 the Federal American Taxpayer  
            Relief Act (FATRA) as part of the "fiscal cliff" deal.  FATRA  
            extended the exclusion from gross income for cancellation of  
            indebtedness (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, and before January 1,  
            2014.  On December 19, 2014, the Federal Government enacted the  
            Tax Increase Prevention Act and again extended, for one  
            additional year, the exclusion from gross income for COD  
            generated from the discharge of QPRI occurring on or after  
            January 1, 2014, and before January 1, 2015.  


          5)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  



          ----------------------------


          <1> Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).








                                                                        AB 99


                                                                       Page E


            increased wealth when the loan is taken out is also offset by  
            the obligation to pay the same amount.  If the debt is  
            cancelled, the symmetry is destroyed.  The borrower is in a much  
            better position after the debt is cancelled.  Additionally, 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.


          6)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 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 - 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.  California law 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.
          7)Insolvency:  COD is not included in income to the extent the  
            taxpayer is insolvent immediately before the debt is cancelled.   











                                                                        AB 99


                                                                       Page F


            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 QPRI 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,  
            meaning that before the cancellation, the taxpayer was insolvent  
            to the extent of $3,000 (total liabilities minus FMV assets).   
            Therefore, the taxpayer may exclude $3,000 from income and  
            include $2,000 as income of the discharged debt.


          8)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.   
            The exclusion of COD from gross income also reduces the burden  
            on a borrower who may be attempting to write-down the loan with  
            his or her 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 recession.


            As noted earlier, one of rationales for excluding mortgage  
            forgiveness from income is to help taxpayers remain in their  
            homes.  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 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  











                                                                        AB 99


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            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),  
            Analysis of the Proposed Tax Exclusion for Cancelled Mortgage  
            Debt Income, January 8, 2008, 2 -8.]


            The recession and drop in housing values are the main factors  
            that led to the original exclusion of COD from gross income.   
            However, over the last few years, the unemployment rate has  
            steadily declined and home values have substantially increased.   
            As of November 2014, California's unemployment rate stood at  
            7.2%, five percentage points lower than its post-recession peak  
            of 12.4%, but 2.4% higher than its pre-recession low of 4.8%.   
            (Public Policy Institute of California, The California Economy:  
            Unemployment Update, December 2014.)  Additionally, the number  
            of seriously "underwater" homes went from a peak of 12.8 million  
            in 2012 to just over seven million in the fourth quarter of  
            2014.  The reduction in underwater homes has primarily been  
            triggered by a 35% increase in the national median home value  
            since bottoming out in 2012.  (RealtyTrac, Seriously Underwater  
            Properties Decrease by 2.2 Million in 2014, Down 5.8 Million  
            From Peak Negative Equity in Q2 2012, January 21, 2015.)  In  
            light of substantial improvements to the economy, the Committee  
            may wish to consider whether an extension of the exclusion for  
            COD generated from the discharge of QPRI is warranted. 


          9)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,  











                                                                        AB 99


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            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.  
          Analysis Prepared by:                          Carlos Anguiano /  
          REV. & TAX. / (916) 319-2098                     FN: 0000638