Tax Administration:

Expanded Information Reporting Could Help IRS Address Compliance Challenges with Forgiven Mortgage Debt

GAO-10-997: Published: Aug 31, 2010. Publicly Released: Sep 30, 2010.

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To assist the growing number of taxpayers facing foreclosure or mortgage restructuring, the Mortgage Forgiveness Debt Relief Act of 2007, and its 3-year extension as part of the Emergency Economic Stabilization Act of 2008, allows taxpayers to generally exclude from taxable income forgiven mortgage debt used to buy, build, or substantially improve a principal residence. Joint Committee on Taxation (JCT) estimates originally suggested that the exclusion of forgiven mortgage debt from taxable income may result in about $968 million in federal revenue losses from fiscal year (FY) 2008 through FY 2013 and more recent estimates suggest that the revenue losses could be closer to $1.9 billion. The Department of Treasury estimates suggest that the exclusion may result in federal revenue losses of about $1.4 billion from FY 2008 through FY 2013. Some taxpayers with forgiven mortgage debts may be bankrupt or insolvent; however, others are not and therefore may have the ability to pay taxes on forgiven mortgage debts. The briefing slides summarize our assessment of the Internal Revenue Service's (IRS) administration of this tax provision. In response to your request, our objectives were to identify 1. the number of taxpayers who have reported the exclusion of forgiven mortgage debt since the program's inception and the dollar amount excluded; 2. the challenges, if any, IRS faces in administering the exclusion and evaluate how effectively IRS is addressing the challenges; and 3. the challenges, if any, taxpayers could face in understanding whether forgiven mortgage debt can be excluded from taxable income and evaluate how to address these challenges.

IRS estimates suggest the dollar amount of forgiven mortgage debt excluded from income could be significant. IRS Statistics of Income (SOI) officials estimate that for tax year 2008, the most current tax year for which data are available, about 126,000 to 169,000 returns included a Form 982, excluding a total of about $15.2 billion to $24.6 billion of forgiven debt from taxable income. IRS estimates suggest that for about 61,000 to 93,000 of the returns with a Form 982, forgiven debt for a qualified principal residence was the only type of forgiven debt, and taxpayers excluded about $6.4 billion to $11.8 billion from taxable income. Additionally, because taxpayers excluding multiple types of debt from income are only required to report the total amount being excluded and not the amount for each individual type, IRS lacks data to determine the dollar amount of forgiven mortgage debt excluded for these taxpayers. IRS faces several compliance challenges in administering this complicated tax provision. IRS officials reported that it may be difficult to collect additional taxes on forgiven debts, particularly when taxpayers are already insolvent and defaulting on debts, and that this and other considerations, such as IRS's return on investment, would affect IRS's decisions about allocating resources for enforcing this provision. However, there is evidence some taxpayers have the ability to pay additional tax if owed, and certain housing market data show that the potential for significant noncompliance with the exclusion of forgiven mortgage debt exists. Over the last 5 years, vacation home and investment property purchases are estimated to have ranged from 40 percent (2005) to 27 percent (2009) of home sales. Current IRS forms provide limited information on mortgage debt forgiveness and IRS is not making full use of all available data. For example, 1) Form 982 does not contain enough information to allow IRS to check for compliance because the form cannot be easily matched against information received from lenders on Form 1099-C. Form 982, Part 1 uses check boxes instead of dollars to report the amount of forgiven debt being excluded. As a result, IRS cannot determine what dollar amounts are being excluded for each type of qualified cancelled debt. 2) Form 1099-C instructions ask lenders to provide an open-ended description of the type of cancelled debt, but do not require the lender to uniformly identify the specific type of cancelled debt. For example, the form does not use a series of check boxes or apply codes so that lenders could select among a list of common cancelled debt types (e.g., mortgage, home equity line of credit, credit card, auto loan, etc.). 3) Neither Form 982 nor Form 1099-C requires the taxpayer or lender to disclose the address of the property secured by the forgiven debt. According to IRS officials, collecting such information might not result in a perfect match in all cases across the two forms. However, it would allow IRS to better determine whether the forgiven debt is for a principal residence. Further, we previously recommended, that IRS consider collecting the address of the secured property on Form 1098, "Mortgage Interest Statement," for taxpayers deducting mortgage interest to help determine the home's use and eligibility for the deduction and improve compliance for taxpayers reporting rental real estate activity. IRS agreed to study the issue. 4) Without being able to systematically identify whether the forgiven debt is for a mortgage, IRS also cannot identify taxpayers who may be eligible for the provision, but are not taking advantage of it. 5) IRS is not using available internal or third-party data to determine whether taxpayers with forgiven mortgage debt own multiple homes--also a potential indicator that the forgiven debt is not for a principal residence.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: IRS disagreed with this recommendation, stating that it believed the benefits of modifying Form 982 would not be justified by the associated costs. Instead, IRS took other actions to help taxpayers and paid preparers understand the tax treatment of cancelled debts and foreclosures.

    Recommendation: To enhance IRS's ability to detect noncompliance with mortgage debt forgiveness provisions, the Commissioner of Internal Revenue should modify Form 982, Part 1 to segregate the total dollar amount of forgiven debt by exclusion type and capture the information in IRS's databases.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: IRS agreed with this recommendation. In December 2011, IRS published a new version of the Form 1099-C for use in 2012. The new version of the form differs in three places from the version at the time of our report. Most significantly, the title of Box 6 has been modified to so that lenders can provide more information to IRS about the type of event that resulted in the cancellation of debt. In addition, IRS published a new version of the instructions for Form 1099-C that specify that lenders enter one of nine codes for the identifiable event in Box 6.

    Recommendation: To enhance IRS's ability to detect noncompliance with mortgage debt forgiveness provisions, the Commissioner of Internal Revenue should modify Form 1099-C to require lenders to identify in a more useable format (check boxes or coding, for example) the specific type of cancelled debt and capture the information in IRS's databases.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Not Implemented

    Comments: IRS disagreed with this recommendation. IRS said that its matching and audit programs are currently identifying non-compliant taxpayers. IRS also reported that the benefits to be derived from the recommendation are outweighed by the additional burden that would be imposed on third-party record keepers in complying. Based on a 2011 study, IRS reached a similar conclusion that collecting a property address on forms for reporting mortgage interest information (Form 1098) would not be worth the additional costs. Still, IRS did conduct a review of Form 1099-C and made some changes to collect additional information that will be useful in the examination process.

    Recommendation: To enhance IRS's ability to detect noncompliance with mortgage debt forgiveness provisions, the Commissioner of Internal Revenue should modify the Form 982 and Form 1099-C so that filers disclose the address of the secured property for which the debt is being forgiven and capture the information in IRS's databases.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Closed - Implemented

    Comments: IRS agreed with this recommendation and examined available IRS and third-party data. According to IRS, these data are useful in determining whether the debt being excluded is for a principal residence and IRS is currently using these data in the examination process.

    Recommendation: To enhance IRS's ability to detect noncompliance with mortgage debt forgiveness provisions, the Commissioner of Internal Revenue should determine if available data (including IRS and third-party data) would allow IRS to better identify whether the debt being excluded is for a principal residence.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Closed - Not Implemented

    Comments: IRS did not agree with this recommendation, stating justifications similar to its responses to other recommendations on modifying the Form 982 and 1099-C to collect the address of the secured property. IRS did, however, revise the Form 1099-C to collect additional information that will be useful in the examination process. Specifically, the modified form requires the creditor to specify the identifiable event that triggered issuance of the form, and to specify the type of discharge for which it was issued.

    Recommendation: To enhance IRS's ability to detect noncompliance with mortgage debt forgiveness provisions, the Commissioner of Internal Revenue should use the additional data reported on the revised Form 982 and Form 1099-C to assess the extent to which taxpayers are compliant.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Closed - Implemented

    Comments: In February 2011 (in time for the 2011 tax filing season), IRS made its interactive tool for canceled debt publicly available. The tool asks taxpayers the same series of questions that would be asked if the taxpayer called the tax law toll-free line.

    Recommendation: To provide better information for paid preparers and taxpayers to determine eligibility for excluding forgiven mortgage debt from taxable income, the Commissioner of Internal Revenue should explore and implement readily available low-cost options to help clarify the tax treatment of forgiven debt, including options such as making IRS's interactive tool for cancelled debt publicly available for the 2011 filing season.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Closed - Implemented

    Comments: IRS agreed with this recommendation and, in 2011, used Contact Analytics to help determine the extent to which taxpayers called IRS about cancellation of debt issues and the reasons they called.

    Recommendation: To provide better information for paid preparers and taxpayers to determine eligibility for excluding forgiven mortgage debt from taxable income, the Commissioner of Internal Revenue should explore and implement readily available low-cost options to help clarify the tax treatment of forgiven debt, including options such as using IRS's telephone software to obtain better information about why, if at all, taxpayers call IRS with questions about forgiven mortgage debt.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  8. Status: Closed - Implemented

    Comments: IRS agreed with this recommendation and, for the 2011 filing season, communicated with tax software companies about the need to more fully support complex debt cancellation issues.

    Recommendation: To provide better information for paid preparers and taxpayers to determine eligibility for excluding forgiven mortgage debt from taxable income, the Commissioner of Internal Revenue should explore and implement readily available low-cost options to help clarify the tax treatment of forgiven debt, including options such as working with software companies to more fully support complex debt cancellation issues, particularly those related to forgiven mortgage debts.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  9. Status: Closed - Not Implemented

    Comments: IRS disagreed with this recommendation because its analysis did not support making the requisite change to Form 1099-C, nor to the return processing system. Still, IRS has continued current education and outreach activities to affected taxpayers. For example, IRS has continued to revise publications that are intended to help taxpayers and paid preparers understand the tax treatment of cancelled debts, foreclosures, repossessions and abandonments.

    Recommendation: To provide better information for paid preparers and taxpayers to determine eligibility for excluding forgiven mortgage debt from taxable income, the Commissioner of Internal Revenue should explore and implement readily available low-cost options to help clarify the tax treatment of forgiven debt, including options such as either sending notices to taxpayers when a lender files a Form 1099-C indicating a forgiven mortgage and the taxpayer does not file a Form 982 or documenting that the costs of doing so would exceed the benefits.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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