Notice 2011-14, 2011-11 IRB
A new Notice explains the income tax and information return consequences of payments made to or on behalf of homeowners under various government programs designed to prevent avoidable foreclosures of homeowners' homes and stabilize housing markets. In general, homeowners may exclude the payments from income, and may deduct all payments they actually make during 2010–2012 to the mortgage servicer, HUD, or the State HFA on the home mortgage. The aid payments aren't subject to information reporting, and there are transition rules for payments that are incorrectly reported.
Background. Payments made under legislatively provided social benefit programs for the promotion of general welfare are not includible in a recipient's gross income. (Rev Rul 74-205, 1974-1 CB 20, Rev Rul 98-19, 1998-1 CB 840)
Under Code Sec. 6041, every person engaged in a trade or business (including state governments and their agencies) must: (1) file an information return for each calendar year in which the person makes in the course of its trade or business payments to another person of fixed and determinable income aggregating $600 or more; and (2) furnish a copy of the information return to that person. And under Code Sec. 6050H, every person engaged in a trade or business (including state governments and their agencies) must: (1) file an information return for each calendar year in which the person receives in the course of its trade or business payments from an individual of interest on a mortgage aggregating $600 or more; and (2) furnish a copy of the information return to that individual.
Finally, Code Sec. 6721 and Code Sec. 6722 impose penalties for failure to comply with the information return rules.
Forgivable loan arrangements. Treasury's Housing Finance Agency (HFA) Hardest Hit Fund provides funds to states that have locally focused programs to address the needs of their financially distressed homeowners. Under an arrangement called the forgivable loan, payments are made to or on behalf of homeowners who have suffered a financial hardship (e.g., unemployment, underemployment, medical condition) and as a result are in danger of losing their homes in foreclosure, or need financial assistance to ensure that their loans become or remain affordable. The terms of the arrangement generally relieve the homeowner of an obligation to make any repayments (the stated principal amount is reduced to zero over time if the homeowner meets certain program requirements). These “forgivable loan” arrangements are generally secured by a subordinate lien on the home and are documented as a zero-percent-interest, nonrecourse, non-amortizing “loan” to the homeowner with a term ranging from 3 to 10 years.
HUD notes. The Department of Housing and Urban Development (HUD) Emergency Homeowners' Loan Program (EHLP) and existing state programs receiving funding from the EHLP (the substantially similar state programs or SSSPs) provide a reasonably necessary amount to assist an eligible homeowner with: (1) a maximum of 24 months of monthly payments of mortgage principal, interest, mortgage insurance premiums, taxes, and hazard insurance; and (2) payments of arrearages (mortgage principal, interest, mortgage insurance premiums, taxes, hazard insurance, late fees, and certain foreclosure-related legal expenses). The assistance that the EHLP and the SSSPs provide to a homeowner must be pursuant to a note (a “HUD note”) with terms and repayment conditions that are similar to a forgivable loan, except that the homeowner must repay the applicable note balance if he defaults on the monthly mortgage payment obligation during the five-year period after the assistance ends. HUD and the SSSPs do not expect homeowners to make more than a minimal amount of payments on the HUD notes.
Tax consequences to homeowners. Notice 2011-14 provides that disbursements under a forgivable loan or HUD note are treated as payments to a homeowner (and not as disbursements of loan proceeds) that are excludable under the general welfare exclusion.
Observation: In Rev Rul 2009-19, 2009-28 IRB 111, IRS similarly ruled that “Pay-for-Performance Success Payments” benefitting homeowners under the federal government's Home Affordable Modification Program (HAMP) are excludable from income under the general welfare exclusion.
For tax years 2010, 2011, and 2012, a homeowner may deduct on his federal income tax return an amount equal to the sum of all payments he actually makes during that year to the mortgage servicer, HUD, or the State HFA on the home mortgage, but not in excess of the sum of the amounts shown on Form 1098, Mortgage Interest Statement, in box 1 (mortgage interest received), box 4 (mortgage insurance premiums) for years 2010 and 2011 only, and box 5 (real property taxes). This safe harbor rule applies for a tax year if the homeowner: (a) meets the requirements of Code Sec. 163 and Code Sec. 164 to deduct all of the mortgage interest on the loan and all of the real property taxes on the principal residence; and (b) participates in the EHLP, an SSSP, or a State Program described in the Appendix to Notice 2011-14, in which the program payments could be used to pay interest on the home mortgage.
Information return responsibilities. Under Notice 2011-14, payments to or on behalf of a homeowner made under state programs, the EHLP, and the SSSP are not subject to Code Sec. 6041. Also, interest received from a governmental unit (or agency or instrumentality) is not reportable under Code Sec. 6050H as interest received on a mortgage.
IRS won't assert penalties under Code Sec. 6721 and Code Sec. 6722 against mortgage servicers that: (1) report on Forms 1098 payments received under a state program, the EHLP or an SSSP during calendar year 2010; or (2) report on Forms 1098 (Mortgage Interest Statement) payments received under a state program, the EHLP, or an SSSP during calendar years 2011 or 2012 if the servicer notifies homeowners that the amounts reported on the Form 1098 are overstated because they include government subsidy payments.
IRS also won't assert penalties under Code Sec. 6721 and Code Sec. 6722 against any state housing finance agency (HFA) for: (1) failing to file and furnish Forms 1098 for calendar year 2010; or (2) failing to file and furnish Forms 1098 for calendar years 2011 and 2012, if the state HFA provides each homeowner and IRS a statement showing: (a) the homeowner's name and taxpayer identification number (TIN); and (b) the amount of payments the state HFA made to a mortgage servicer under the State Program or the SSSP during that year (separately stating the amount the state HFA paid and the amount the homeowner paid). The statement the state HFA provides to IRS must be a single statement that separately lists the names, TINs, and relevant payment amounts for each homeowner.
For calendar years 2011 and 2012, the department of Housing and Urban Development is directed to provide each homeowner and IRS a statement setting forth (1) the homeowner's name and TIN, and (2) the amount of payments HUD made to the mortgage servicer under the EHLP during that year (separately stating the amount HUD paid and the amount the homeowner paid). The statement HUD provides to IRS should be a single statement that separately lists the names, TINs, and relevant payment amounts for each homeowner.
References: For the “general welfare exclusion” from income, see FTC 2d/FIN ¶J-1480A; TaxDesk ¶198,201.