BILL ANALYSIS Ó
AB 99
Page A
GOVERNOR'S VETO
AB
99 (Perea)
As Enrolled September 3, 2015
2/3 vote
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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
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|ASSEMBLY: |80-0 |(June 1, 2015) |SENATE: |40-0 |(September 1, |
| | | | | |2015) |
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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
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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)Provides 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
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
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"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.
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.
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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 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
---------------------------
<1> Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
(1955).
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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. 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,
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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
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
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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, 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.
GOVERNOR'S VETO MESSAGE:
I am returning the following nine bills without my signature:
Assembly Bill 35
Assembly Bill 88
AB 99
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Assembly Bill 99
Assembly Bill 428
Assembly Bill 437
Assembly Bill 515
Assembly Bill 931
Senate Bill 251
Senate Bill 377
Each of these bills creates a new tax credit or expands an
existing tax credit.
Despite strong revenue performance over the past few years, the
state's budget has remained precariously balanced due to
unexpected costs and the provision of new services. Now, without
the extension of the managed care organization tax that I called
for in special session, next year's budget faces the prospect of
over $1 billion in cuts.
Given these financial uncertainties, I cannot support providing
additional tax credits that will make balancing the state's
budget even more difficult. Tax credits, like new spending on
programs, need to be considered comprehensively as part of the
budget deliberations.
AB 99
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Analysis Prepared by: Carlos Anguiano /
REV. & TAX. / (916) 319-2098 FN: 0002534