BILL ANALYSIS Ó
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| SENATE RULES COMMITTEE | SB 907|
|Office of Senate Floor Analyses | |
|(916) 651-1520 Fax: (916) | |
|327-4478 | |
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THIRD READING
Bill No: SB 907
Author: Galgiani (D), et al.
Amended: 3/28/16
Vote: 27 - Urgency
SENATE GOVERNANCE & FIN. COMMITTEE: 7-0, 3/30/16
AYES: Hertzberg, Nguyen, Beall, Hernandez, Lara, Moorlach,
Pavley
SENATE APPROPRIATIONS COMMITTEE: 7-0, 5/27/16
AYES: Lara, Bates, Beall, Hill, McGuire, Mendoza, Nielsen
SUBJECT: Personal income taxes: gross income exclusion:
mortgage debt forgiveness
SOURCE: Author
DIGEST: This bill extends conformity to federal law's income
exclusion for discharges of qualified principal residence
indebtedness.
ANALYSIS:
Existing law:
1)Conforms to the Mortgage Forgiveness Debt Relief Act of 2007
(MFDRA) for debt discharged on or before January 1, 2014, and
provides that no penalties or interest applies for discharge
of qualified principal residence indebtedness, regardless of
whether the taxpayer reports the discharge on his or her
income tax return (SB 1055, Machado, Chapter 282, Statutes of
2008; SB 401, Wolk, Chapter 14, Statutes of 2010; and AB 1393,
Perea, Chapter 152, Statutes of 2014).
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Page 2
2)Contains slightly different limits for mortgage debt
forgiveness than federal law:
a) Taxpayers may only exclude up to $250,000
single/$500,000 joint of cancelled debt from income for
state purposes, but can exclude an unlimited amount of
cancelled income for federal purposes.
b) Taxpayers may only exclude indebtedness on loans up to
$400,000 single/$800,000 joint of qualified principal
residence indebtedness, instead of $1 million/$2 million
for federal. The taxpayer must first reduce any amount
excluded for state tax purposes by any debt forgiven on
loan amounts above $400,000/$800,000.
This bill:
1)Extends California's modified conformity to the Mortgage
Forgiveness Debt Relief Act by excluding from income for state
tax purposes any discharge of qualified principal residence
indebtedness made between January 1, 2014 and January 1, 2017.
2)Makes legislative findings and declarations stating that its
retroactive application does not constitute a gift of public
funds.
Background
When a lender cancels a borrower's debt, federal and state law
generally treat the amount of debt cancelled as income taxable
to the borrower. Taxpayers do not include borrowed funds in
income in the year he or 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 that
have already been received and not previously taxed need not be
repaid. In U.S .v. Kirby Lumber Co., 284 US 1 (1931), the
United States 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 generated a taxable gain. Congress
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subsequently deemed cancelled debt as income, with exceptions
for:
1)Debts discharged in bankruptcy
2)When the taxpayer is insolvent, debt discharge is excluded up
to the amount of the insolvency, but triggers specified basis
adjustments,
3)Certain farm debts, and
4)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
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, such
as a deed-in-lieu of foreclosure or a foreclosure, usually
results in taxable income for the borrower
In 2007, Congress enacted the Mortgage Forgiveness Debt Relief
Act of 2007 (MFDRA), which provides that taxpayers may exclude
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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 separately
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. In 2014, Congress
again extended mortgage debt forgiveness through the 2014
taxable year when it enacted the Tax Increase Prevention Act
(TIPA). Most recently, Congress enacted the Protecting
Americans from Tax Hikes (PATH) Act of 2015, which extended
forgiveness for two years, applying to discharges made on or
before December 31, 2016 year, and for discharges past that date
so long as the discharge was made pursuant to a written
agreement entered into before January 1, 2017.
California first conformed to MFDRA in 2008, and again in 2010,
for debt discharged on or before December 31, 2012, and
additionally provided that no penalties or interest applies for
discharge of qualified principal residence indebtedness,
regardless of whether the taxpayer reports the discharge on his
or her income tax return (SB 1055, Machado, 2008, and SB 401,
Wolk, 2010). However, those bills applied slightly different
limits than federal law:
1)Taxpayers may only exclude up to $250,000 single/ $500,000
joint of cancelled debt from income.
2)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.
The Legislature extended mortgage debt relief for discharges of
indebtedness made before January 1, 2014 (AB 1393, Perea, 2014),
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Page 5
but remains out of conformity for mortgage debt forgiven in 2014
because the Governor vetoed AB 99 (Perea, 2015), as well as for
discharges in 2015. The author wants to extend mortgage debt
forgiveness for the 2014 discharges, and conform to the PATH
Act's mortgage debt forgiveness provisions.
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 non-recourse, 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 (SB 931, Ducheny, Chapter 701, Statutes of 2010).
In 2011, the Legislature extended that treatment for all
residential mortgages, including second mortgages after a short
sale (SB 458, Corbett, Chapter 82, Statutes of 2011).
Related/Prior Legislation
AB 99 (Perea, 2015) would have extended California's income
exclusion for mortgage debt forgiven in the 2014 year. Governor
Brown vetoed the measure using the same veto message that he
issued for several other bills, stating:
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.
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FISCAL EFFECT: Appropriation: No Fiscal
Com.:YesLocal: No
According to the Senate Appropriations Committee, "the Franchise
Tax Board (FTB) estimates that the bill would result in General
Fund revenue losses of $95 million in 2015-16, $45 million in
2016-17, and $12 million in 2017-18. FTB would incur minor
administration expenses."
SUPPORT: (Verified5/27/16)
Attorney General Kamala Harris
BOE Member George Runner
California Association of Realtors
California Bankers Association
California Credit Union League
California Mortgage Bankers Association
California Reinvestment Coalition,
California Society of Enrolled Agents
California Taxpayers Association
Center for Responsible Lending
Consumers Union
Housing and Economic Rights Advocates
OPPOSITION: (Verified5/27/16)
None received
ARGUMENTS IN SUPPORT: According to the author, "SB 907 would
extend the tax relief on forgiveness of mortgage debt by
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conforming California law to the Federal Tax Increase Prevention
Act of 2014 and the Protecting Americans from Tax Hikes Act PATH
Act of 2015. 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. This bill would apply to the tax years: 2014, 2015,
and 2016."
Prepared by:Colin Grinnell / GOV. & F. / (916) 651-4119
5/28/16 17:11:55
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