September 14,2009

Grassley, Colleagues Urge IRS to Help Tax Burden of Home Loan Debt Forgiveness on Working Families

WASHINGTON – Sen. Chuck Grassley, ranking member of the Committee on Finance,along with two fellow Finance Committee members, is urging the Treasury Department and InternalRevenue Service (IRS) to take action to ensure that working families who lose their homes toforeclosure face more reasonable, accurate tax bills for their home loan debt forgiveness.

“Working families who lose their homes are getting hit with huge tax bills,” Grassley said.“Some of those bills are unfairly high and even inaccurate. The IRS needs to take steps to ensurethe accuracy of the bill in the first place. Then the IRS should offer the taxpayer every opportunityto negotiate the of the bill and a fair payment plan. The agency has plenty of authority to treattaxpayers reasonably in these situations. It needs to use that authority to serve taxpayers.”

Grassley and fellow Finance Committee members Sens. Gordon Smith of Oregon and PatRoberts of Kansas wrote to the Treasury secretary to urge these changes. The text of their letterfollows here. Also pasted below is the text of a New York Times story describing the postforeclosuretax problem.

September 13, 2007The Honorable Henry Paulson Jr.SecretaryU.S. Department of Treasury1500 Pennsylvania Avenue, NWWashington, DC 20220

Dear Mr. Secretary:

We are writing to you regarding the President’s recent proposal to provide that cancelledmortgage debt on a primary residence is not counted as income. Many Americans are facing realfinancial difficulties because of increased mortgage payments. These families are often confrontingthe reality of defaulting and losing their home or seeking to work with lenders to significantly reducethe loan amount. As these families struggle to reduce their home loan debt they are hit by taxes thatare due to debt forgiveness from the lender. The President is right to seek relief for these workingfamilies.

While the Congress considers the President’s proposal, Americans shouldn’t have to waitto get the relief that is needed right now. We strongly urge the Treasury Department to takeimmediate steps to encourage working families that face the difficulties that the President outlinedin his speech on August 31, 2007, to submit (and have the Internal Revenue Service [IRS] accept)offers in compromise that will either eliminate or reduce the taxes that they owe due to cancelledmortgage debt on a primary residence.

Congress has granted IRS broad authority to compromise a tax liability under Section 7122.Perhaps most relevant here is that the Treasury Department has interpreted that authority such that“. . . IRS may compromise to promote effective tax administration where compelling public policyor equity considerations identified by the taxpayer provide a sufficient basis for compromising theliability.” Treas. Regs. 301.7122-1(b)(3)(ii). President Bush on August 31, 2007, made the casehimself for a compelling public policy rationale, stating: “When your home is losing value and yourfamily is under financial stress, the last thing you need to do is to be hit with higher taxes.”

We recognize that it would be simpler to change the law to provide relief; however, the topgoal we all share is providing relief for working families in financial stress as quickly as possible.If the IRS issues simple procedures for taxpayers to file an offer in compromise -- and undertakesa significant program of outreach to taxpayers, practitioners and lenders – much good can beaccomplished immediately.

Taxpayers are also facing an additional problem in that lenders are providing taxpayersinaccurate 1099s for the amount of debt forgiveness as was recently reported by the New YorkTimes. The IRS should be aggressively educating lenders, practitioners and affected taxpayers toensure that accurate 1099s are being provided. Too often the IRS emphas dealing with problemson the back-end as opposed to preventing a problem at the beginning. We encourage you to havethe IRS undertake preventive action in this area immediately. To just refer to documents, as the IRSdid in the New York Times article, is not enough.

Finally, while we believe the IRS and Treasury have broad authority to undertake theproposals we have outlined, please inform us promptly if you believe additional authority is needed.The Finance Committee is expected to mark up the “Good Government” legislation next week andthat would be an appropriate vehicle to consider any additional authorities required.Thank you for your time and consideration to this important matter.

Cordially yours,

Senator Charles GrassleyRanking MemberSenator Gordon SmithSenator Pat Roberts

The New York TimesAugust 20, 2007 MondayLate Edition - FinalAfter the Pain Of Foreclosure, A Big Tax Bill


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Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could nolonger make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom housefor sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, countyrecords show.

Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a newstart. He married and moved in with his wife, Denise.

But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. Theletter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes,as well as penalties and late fees. The couple had a month to challenge the charges.

For those who struggle to pay their bills, who watch their housing payments rise out of reach withtheir adjustable-rate mortgages, who lose a job or who fall victim to illness, losing one's home canfeel like hitting bottom. But one more financial indignity may await as the fallout from the greathousing boom ripples across the United States.

''Getting that tax bill,'' Mrs. Stout recalled, ''my first thought was that I needed to see my familydoctor to help me with my stress, because we had a big mortgage and other debt and then here camethe I.R.S. saying we owe this.''

Notices of unpaid taxes, unanticipated and little understood, will probably multiply as more peoplefall behind on their mortgages, said Ellen Harnick, senior policy counsel at the Center forResponsible Lending, a nonpartisan research and policy center in Durham, N.C.

Foreclosure is one way that beleaguered homeowners can fall into this tax trap. The other is whenhomeowners are forced to sell their homes for less than the value of the mortgage. If the lenderforgives that difference, they are liable for income taxes on that amount.

The 1099 shortfall, as it is called, stems from an Internal Revenue Service policy that treats forgivendebt of all types as income even if the taxpayer has nothing tangible to show for it, unless the debtis canceled through bankruptcy.

The Center for Responsible Lending expects that 20 percent of the home loans made in 2005 and2006 to people with weak credit, commonly called subprime loans, will end in foreclosure. Becauseso little money was required as a down payment during the boom, the value of many of these housesmay be less than what is owed.

Some people in this predicament are fighting the I.R.S. and winning. Sometimes, lower paymentscan be negotiated with the I.R.S., tax experts say.

In other cases, bankruptcy or a claim of insolvency can eliminate the tax burden. Sometimes, thebills are sent out erroneously, as banks fail to keep track of home values and what price theproperties ultimately sell for.

''The tax laws are far too complex for borrowers to understand,'' said Kurt Eggert, a professor atChapman University School of Law, noting that there are distinctions between selling a house forless than the loan amount and losing one in foreclosure. He says it is crucial to get expert tax adviceto sort through the bewildering complications.

The whole concept can be counterintuitive. ''Your home has declined in value and you lose it,'' Mr.Eggert said. ''Then the I.R.S. says you owe tens of thousands in taxes because you got a windfallwhen the debt was forgiven.''

Mr. Stout has suffered doubly from the downturn in the housing market. He earned $65,000 last yearas a salesman for a roofing company. But last winter, his job was cut from a salaried position to anhourly one. Then his hours were reduced, as construction demand eased. Through July he had earnedonly $25,000, said his lawyer, Stephen G. Doherty, of Bennett & Doherty in Doylestown, Pa.,putting him on pace for a pay cut over all this year.

Mr. Doherty set out to appeal the Stouts' tax bill by arguing that Wells Fargo got the home ascollateral so the family did not reap a benefit. The Stouts and their lawyer also hoped to show thatWells Fargo was able to sell the house for far more than $1. Finally, they contended that penaltieswere inappropriate because they did not receive a tax notice in 2005 or 2006.

After a reporter inquired about the Stout matter, Wells Fargo Home Mortgage said last week thatit had reviewed the Stouts' tax documents and was filing a corrected 1099 tax form to show that nodebt had been canceled, because the fair market value of the home was actually more than Mr. Stouthad owed.

Mr. Doherty, the Stouts' lawyer, pointed out that the acquiring lender, in this case Wells Fargo, hassome leeway in valuing a house. The fair market value can be the high bid at a sheriff's sale, or analternative valuation.

In this case, Wells Fargo's about-face was tied to an appraisal that Mr. Doherty says he believes wascompleted before the sale. It set the value of the house at $132,844, eliminating the Stouts' liability.(Lenders do periodic appraisals once a property is in default, Mr. Doherty said.)The Stouts found in county records that Wells Fargo had sold the house to U.S. Bank for $106,000 --the same amount Mr. Stout had owed -- in March 2006. The house was resold that month for$140,000.

An I.R.S. spokesman would not comment on the Stout matter or how the agency applies the tax ruleson forgiven debt, but referred to a document on the I.R.S.'s policies.Diane Thompson, a lawyer in Godfrey, Ill., for the National Consumer Law Center, says the tax canbe a real hardship for some people.

She recalled a client who owed $39,000 to her lender and got a tax bill after her house was sold inforeclosure for $10,000. Ms. Thompson appealed to tax authorities, contending that her client, apart-time waitress, was broke because her debts were greater than her assets.

''If you can prove you are insolvent, the I.R.S. does not treat the forgiveness of debt as income,'' Ms.Thompson said. Her client did not have to pay.

Lawyers may also be able to show that the original loan process was so flawed that the borrower isnot liable for taxes. Indeed, during the real estate bubble, lenders and mortgage brokers sometimesencouraged homeowners to borrow more based on inflated home values.

Such was the case with Agnes Mouser, a 65-year-old widow who works in the records departmentin a Houston prison. In 2000, she sought to pay off her credit-card debt with a loan from BeneficialFinance, which sent an appraiser to assess the value of her home.

''A real nice young man came out to see me,'' Mrs. Mouser recalled. ''He could have been mygrandson.''

That appraiser compared her 1977 mobile home with two new standard homes with two-car garages.Using those homes as benchmarks, Beneficial agreed to lend $34,730 on her home, valued at$43,500, in 2000. Mrs. Mouser's loan carried an interest rate of 14.88 percent, and she paid 7 points,or $2,431, at closing to get that rate, along with $270 to Beneficial for the appraisal.

A spokeswoman for HSBC, the parent company of Beneficial, said it did not comment on mattersinvolving specific customers.

In 2003, when Mrs. Mouser could not meet the payments, she contacted Ira D. Joffe, a lawyer inHouston. He found that her property was valued by the county at $19,970, less than half of whatBeneficial had estimated.

''I promised to depose the appraiser's Seeing Eye dog if there was a lawsuit,'' Mr. Joffe recalledtelling Beneficial.

Beneficial released the lien. But then Mrs. Mouser got a tax bill for $10,000, or the amount owedon the $29,566 that Beneficial had treated as a canceled loan.

''The tax bill scared her to death,'' Mr. Joffe recalled. ''It took a letter from an accountant and twoletters from me to get the I.R.S. to go away.''-30-