BILL ANALYSIS Ó
AB 99
Page A
ASSEMBLY THIRD READING
AB
99 (Perea)
As Amended May 20, 2015
2/3 vote. Urgency
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|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.
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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
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<1> Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
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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.
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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