Tax Administration: Expanded Information Reporting Could Help IRS Address Compliance Challenges with Forgiven Mortgage Debt
Published: 2010-08-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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 contained in appendix I, provided to your offices on July 28,  2010, and subsequently updated, summarizes 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.
To meet these objectives, we worked with IRS officials to determine the  availability of information on the tax treatment of forgiven mortgage debt;  analyzed IRS data on the number and dollar amounts of cancelled debts  between 2007 and June 2010; analyzed related forms and publications,  education and outreach materials, and actions taken by IRS to inform  taxpayers, tax software companies, and paid preparers about the tax  treatment of cancelled mortgage debt; reviewed a selected sample of tax  preparation software packages from tax software providers that cover 90  percent of the market; and interviewed IRS officials and housing market  experts familiar with the current condition of the housing market,  including trends in foreclosure and debt cancellation. We interviewed IRS  officials about how they produced estimates on the number and dollar  amount of forgiven debts and the reliability of those estimates. We also  interviewed housing market experts that we frequently consult about data  such as foreclosures and home sales, and determined that the data  included in this briefing were sufficiently reliable for our purposes.
We conducted this performance audit from July through August 2010 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: Taxpayers are to report all cancelled debt, including mortgage debt,  excludable from taxable income by completing Form 982, “Reduction of  Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis  Adjustment).” Taxpayers use Part 1 of this form to report reasons why  cancelled debt can be excluded from taxable income. Taxpayers who are  in bankruptcy or insolvent are to exclude their forgiven mortgage debt  under the bankruptcy or insolvency category on the Form 982. Taxpayers  with forgiven mortgage debt who are not bankrupt or insolvent are to  exclude forgiven mortgage debt under the qualified principal residence  category on the Form 982. Thus, these taxpayers may have the ability to  pay taxes on forgiven debts because they are not in bankruptcy or  insolvent. Lenders report all types of cancelled debts to IRS on Form 1099- C, “Cancellation of Debt.”
With some exceptions, a cancelled or modified debt is considered taxable  income for taxpayers who are not insolvent or in bankruptcy. Without the  Mortgage Forgiveness Debt Relief Act and its extension, millions of  homeowners currently facing foreclosure could be liable for income taxes  on the discharge of debt on their principal residence.
section_title: Results
paragraphs: 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, as noted  above, 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. For example, housing market experts who publish regular  foreclosure and delinquency surveys confirmed to us that mortgages on  vacation and investment homes may account for a substantial portion of  current delinquencies and foreclosures. 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,    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.
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.).
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.
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.
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.
Without having an estimate of the extent of noncompliance, IRS is unable  to determine whether additional resources should be dedicated to  compliance monitoring for mortgage debt forgiveness or if automated  compliance checks are needed.
At the same time, little concrete information exists to measure the extent  to which paid preparers and taxpayers experience difficulty adhering to  mortgage debt forgiveness provisions due to the complexity of the law,  IRS forms, and instructions. However, anecdotal evidence suggests IRS’s  forms and instructions and the related tax laws are difficult to understand.  For example, IRS officials acknowledged that the law is confusing and the  National Taxpayer Advocate described Form 982 as “technically  challenging.” As a result, IRS has taken actions to reduce the complexity  associated with filing the Form 982, including revising the form’s  instructions and engaging in outreach to paid preparers and software  providers on cancelled debt. Currently, the most frequently used  commercial software packages provide varying degrees of support for  Form 982. In addition, IRS has not explored several low-cost and easy-to- implement options that could help it clarify how to treat forgiven mortgage  debt for tax purposes. These options include the following:    Releasing to paid preparers, software companies, or taxpayers an  existing interactive tool on cancellation of debt which is similar to  tools already released for other tax laws in that it enables users to  navigate a series of questions about taxpayers’ particular cancelled  debt circumstances. IRS officials reported that making this tool  publicly available would introduce some additional costs. However,  based on our observation of the tool, it may clarify the tax treatment of  forgiven debt, including mortgage debt, for tax purposes.
Using telephone software to analyze the reasons why taxpayers call  IRS with questions about the tax treatment of forgiven mortgage debt.
Encouraging software companies to provide more interactive features  that would help taxpayers answer a series of questions about more  complex cancelled debt situations, and, if applicable, subtract  ineligible amounts of debt from the total being excluded from income.
section_title: Conclusions
paragraphs: IRS is responsible for enforcing complex tax laws and must consider  trade-offs when allocating its enforcement resources, such as the ability to  collect assessed taxes and return on investment. Deteriorating trends in  the housing market have led to an increase in the number and amount of  forgiven mortgage debts, which have complex tax consequences.  However, IRS is missing opportunities to both identify noncompliance and  assist eligible taxpayers in excluding forgiven mortgage debt before the  provision expires at the end of 2012. Revising the forms, collecting more  information from taxpayers and lenders, and using third-party data would  help IRS determine whether taxpayers are correctly excluding mortgage  debt from taxable income and whether IRS needs to dedicate additional  resources to this issue. Further, providing greater assistance to taxpayers  and expanding outreach to stakeholders are low-cost solutions that could  help better highlight the potential tax consequences of cancelled debts.
section_title: Recommendations for Executive Action
paragraphs: We recommend that the Commissioner of Internal Revenue take the  following nine actions.
To enhance IRS’s ability to detect noncompliance with mortgage debt  forgiveness provisions,  (1) 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;  (2) 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;  (3) 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;  (4) 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; and  (5) use the additional data reported on the revised Form 982 and Form  1099-C to assess the extent to which taxpayers are compliant.
To provide better information for paid preparers and taxpayers to  determine eligibility for excluding forgiven mortgage debt from taxable  income, explore and implement readily available low-cost options to help  clarify the tax treatment of forgiven debt, including options such as  (6) make IRS’s interactive tool for cancelled debt publicly available for the  (7) use IRS’s telephone software to obtain better information about why, if  at all, taxpayers call IRS with questions about forgiven mortgage debt;  (8) work with software companies to more fully support complex debt  cancellation issues, particularly those related to forgiven mortgage  debts; and  (9) either send 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 document that the costs of doing so would exceed the benefits.
section_title: Agency Comments
paragraphs: We provided a draft of this report to the Commissioner of Internal  Revenue. We received written comments from the Deputy Commissioner,  Services and Enforcement; his comments are reprinted in appendix II. He  stated that IRS agreed with five of the nine recommendations and said that  the other four, related to making changes to the Forms 982 and 1099-C and  collecting the resulting data, have significant value. However, the Deputy  Commissioner raised the question of whether the costs of making the  changes would outweigh the benefits and said that before taking action on  the four recommendations, IRS would ascertain the costs and benefits.
We agree that costs and benefits should be considered, but we are not sure  a useful estimate is possible in this case. As our report states and IRS  acknowledges, the lack of data presents challenges in estimating the  extent of noncompliance and, therefore, the benefits of additional IRS  action. The Deputy Commissioner stated that IRS will review a sample of  tax returns filed with Form 982 and analyze available third-party data to  determine the character of the cancelled debt. However, our report— based on interviews with IRS officials—said that the available third-party  data reported on Form 1099-C do not contain information in a format that  could help to systematically determine eligibility. Thus, IRS’s review of a  sample of tax returns using only currently available data risks understating  the benefits of additional information reporting.  To avoid the challenge of  developing a complete benefit estimate, we recommended that IRS make  relatively minor changes to the Forms 982 and 1099-C that would not  impose significant additional burden on taxpayers or third parties.  By  collecting such additional data, albeit at some cost, IRS would be better  positioned to determine whether additional resources are needed to  monitor compliance with forgiven mortgage debt rules.
IRS also provided technical changes to the report, which we incorporated  where appropriate.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the Chairmen and Ranking  Members of other Senate and House committees and subcommittees that  have appropriation, authorization, and oversight responsibilities for IRS.  We will also send copies to the Commissioner of Internal Revenue, the  Secretary of the Treasury, the Chairman of the IRS Oversight Board, and  the Director of the Office of Management and Budget. The report also will  be available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions or wish to discuss the material in  this report further, please contact me at (202) 512-9110 or at  whitej@gao.gov. Contact points for our Offices of Congressional Relations  and Public Affairs may be found on the last page of this report. Major   contributors to this report were Joanna Stamatiades, Assistant Director;  Amy Bowser; James Cook; John Dell’Osso; Tom Gilbert; Mark Kehoe;  Kirsten Lauber; Patricia MacWilliams; Jessica Thomsen; Benjamin Wories;  and Jeff Wojcik.
section_title: Appendix I: Updated Slides from the July 28, 2010 Congressional Briefing
subsections: section_title: Forgiven Mortgage Debt
subsections: section_title: Mortgage Debt Forgiveness Objectives
subsections: section_title: 2. What challenges, if any, does IRS face in administering the exclusion of
paragraphs: forgiven mortgage debt from taxable income and how effectively is IRS  addressing the challenges? 3. What challenges, if any, could taxpayers face in understanding whether  forgiven mortgage debt can be excluded from taxable income and what  steps can be taken to address these challenges?
section_title: Results
paragraphs: IRS estimates suggest the dollar amount of forgiven mortgage debt excluded from income  could be significant.
Although conditions in the current housing market suggest that the potential for significant  noncompliance exists, IRS is unable to measure the extent to which taxpayers are compliant  with the mortgage debt forgiveness exclusion. Information provided on IRS Forms 982 and  1099-C does not allow IRS to systematically check for noncompliance, nor does IRS require  lenders or taxpayers to report the address of the property secured by the mortgage debt being  forgiven. Without such information, IRS is unable to determine what additional resources, if  any, are needed to ensure compliance.
The complexity of tax provisions regarding forgiven mortgage debt, as well as IRS forms and  instructions, makes it difficult for taxpayers to determine whether and what portion of forgiven  mortgage debt can be excluded from income. However, IRS has not explored several low-cost  options that would be relatively easy to implement and would help clarify the tax treatment of  forgiven debt for tax purposes including making existing interactive tools available, using  existing telephone software, and conducting further outreach to external stakeholders.
section_title: Scope and Methodology
subsections: section_title: To accomplish our objectives, we
paragraphs: worked with IRS officials to determine the availability of information related to  the tax treatment of forgiven mortgage debt;  analyzed IRS data concerning the number and dollar amount of cancelled  debts from 2007 through June 2010;  analyzed related forms and publications, education and outreach materials, and  actions taken by IRS to inform taxpayers, tax software companies, and paid  preparers about the tax treatment of cancelled mortgage debt; reviewed how tax software packages from companies that cover 90 percent of  the market treat forgiven mortgage debt; and interviewed IRS officials about a variety of issues, and housing market experts  from an industry association and a private research company familiar with the  current condition of the housing market, including trends in foreclosure and  debt cancellation.
section_title: We conducted this performance audit from July 2010 through August 2010 in accordance with generally accepted government auditing standards. We interviewed IRS officials and housing market experts about available data and determined that the data included in this briefing were sufficiently reliable our purposes.
section_title: Background
subsections: section_title: The Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110-142) generally allows homeowners to exclude forgiven mortgage debt from taxable income for a principal residence (subject to a variety of restrictions that introduce varying degrees of complexity) from 2007 to 2009. The Emergency Economic Stabilization Act of 2008 (P.L. 110-343) extended this through 2012.
paragraphs: Includes both debt forgiven through foreclosure and loan modification as long as discharge  of debt was due to a decline in the value of the residence or the financial condition of the  taxpayer.
The mortgage debt must have been used to buy, build, or substantially improve a  principal residence and must be secured by the property.
section_title: Historically, if a lender cancelled a debt, it has been subject to taxes, with exceptions
paragraphs: made for taxpayers who are insolvent or in bankruptcy.
section_title: Background (cont.)
subsections: section_title: Taxpayers report mortgage debt excluded from taxable income by
paragraphs: bankruptcy, insolvency,  qualified farm indebtedness,  qualified real property business indebtedness,  qualified Midwestern disaster area indebtedness, or  qualified principal residence indebtedness.
section_title: Lenders report all types of cancelled debts to IRS on Form 1099-C,
paragraphs: “Cancellation of Debt.”
section_title: Background (cont.)
paragraphs: 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 2013.2  This suggests that not all taxpayers with forgiven mortgage debt are bankrupt  or insolvent and may have the ability to pay taxes on forgiven debts.
Taxpayers who are in bankruptcy or insolvent are to exclude forgiven  mortgage debt under the bankruptcy or insolvency category on Form 982.
Taxpayers with forgiven mortgage debt who are not bankrupt or insolvent  are to exclude forgiven mortgage debt under the qualified principal  residence category on Form 982.
We added revenue loss estimates from the President’s fiscal years 2010 and 2011 budget requests, Feb. 26, 2009, and Feb. 1, 2010, respectively.
subsections: section_title: Objective 1: IRS Estimates Suggest the Dollar Amount of Forgiven Mortgage Debt Excluded from Income Could be Significant
paragraphs: Based on a sample of 2008 tax returns, IRS Statistics of Income (SOI)  officials estimate that for tax year (TY) 2008, 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 also suggest that for about 61,000 to 93,000 of the returns  with a Form 982, debt for qualified principal residence was the only type  of forgiven debt, and taxpayers excluded about $6.4 billion to $11.8  billion from taxable income.
Because taxpayers excluding multiple types of debt only report the total  amount being excluded, and not individual debt amounts, IRS lacks the  data to determine the dollar amount of forgiven mortgage debt excluded  for these taxpayers.
section_title: Objective 2: IRS Challenges – Potential for Significant Noncompliance Exists
paragraphs: In the absence of detailed audits, IRS does not know the extent of noncompliance  for forgiven mortgage debt. However, we identified several conditions suggesting the  potential for significant noncompliance exists. 1. Housing market data show significant amounts of forgiven mortgage debt could  be taxable income.
Real estate market experts estimate that, in 2010, over 3 million foreclosure filings will  take place, while about 1 million homes will be repossessed by lenders.Housing  market experts who publish regular foreclosure and delinquency surveys confirmed to  us that mortgages on vacation and investment homes may account for a substantial  portion of current delinquencies and foreclosures.  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.
Taxpayers who own second homes or investment properties may differ in their  ability to pay taxes than taxpayers with a single residence.
During the height of the housing market, homeowners withdrew increasing amounts of  housing-secured equity through refinancing, second mortgages, and lines of credit.   Estimates of the amount withdrawn in 2005 range from $301 billion to 515 billion.However, IRS is unable to determine whether the proceeds from these loans were  used to buy, build, or substantially improve a principal residence.
section_title: IRS Challenges – Potential for Significant Noncompliance Exists (cont.)
paragraphs: 2.
IRS data show a significant increase in the amount and number of cancelled debts since TY 2007.
IRS estimates the amount of cancelled debt reported on Form 1099-C  has increased over 10 times—from about $19 billion worth of debt in TY  2007 to about $216 billion worth of debt for TY 2009 (as reported to IRS  through June 2010).
The number of Form 1099-Cs has increased about 80 percent from about  2 million debts to about 3.6 million debts.
However, IRS is unable to identify the extent to which this increase is  attributable to foreclosures and mortgage modifications, and particularly  to debt attributable to a principal residence.
section_title: IRS Challenges – Potential for Significant Noncompliance Exists (cont.)
paragraphs: 3.
IRS dedicates minimal resources in this area and is unable to report  how many returns have been subject to further examination due to cancellation of debt issues, including forgiven mortgage debt.
The Automated Underreporter (AUR) program does not pursue  underreported income from cancelled debts over certain thresholds  based on the assumption that such cancelled debts would be for  mortgages and yield little change in the amount of tax owed.
Using a rationale similar to AUR, the Wage and Investment examination  division does not include cancelled debts or mortgage debt forgiveness  as part of the examination process.
The Small Business/Self-Employed division may include mortgage  cancellations as part of broader audits of taxpayers, including requiring  taxpayers to supply supporting documentation related to debt  cancellation.
section_title: IRS Challenges – Potential for Significant Noncompliance Exists (cont.)
subsections: section_title: According to IRS officials, it may be difficult to collect additional taxes on
paragraphs: forgiven debts, particularly when taxpayers are already insolvent and  defaulting on debts, and that this and other considerations, such as return  on investment, would affect IRS’s decisions about allocating resources for  enforcing this provision.
There is evidence that some taxpayers have the ability to pay additional  tax, if owed.
JCT and Treasury revenue loss estimates suggest that without the  exclusion, forgiven mortgage debts would generate federal revenue.
Taxpayers selecting the qualified principal residence category on the  Form 982 are indicating that they are not in bankruptcy or insolvent  because if they were, they would be claiming the exclusion under the  “bankruptcy” or “insolvency” category on the Form 982 (as we noted  earlier).
section_title: IRS Challenges – Current IRS Forms Provide Limited Information on Mortgage Debt Forgiveness
paragraphs: Several limitations with Form 982 and Form 1099-C make it difficult for  IRS to measure noncompliance.
Form 982 does not contain enough information to allow IRS to check for  compliance because the form cannot be 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 debts.
section_title: IRS Challenges – Current IRS Forms Provide Limited Information on Mortgage Debt Forgiveness (cont.)
subsections: section_title: Possible changes to Form 982 to enhance compliance
paragraphs: Check boxes could be replaced with actual dollar amount of the cancelled debt that  the taxpayer is excluding from income.
section_title: IRS Challenges – Current IRS Forms Provide Limited Information on Mortgage Debt Forgiveness (cont.)
paragraphs: Form 1099-C does not provide information in a format that could help  determine eligibility, including what type of debt (mortgage, credit card,  car loan, etc.) is being forgiven.
Although IRS receives nearly all 1099-C information returns electronically, the  information cannot be used by itself to determine whether the cancelled debt  is for a mortgage. IRS instructions ask lenders to be as specific as possible  when describing the type of debt being forgiven, but do not require lenders to  uniformly identify the specific type of cancelled debt. For example, lenders  filing 1099-Cs do not select from a list of types of forgiven debt when  completing box 4, which describes the type of debt being forgiven. Because  box 4 is an open-ended description, IRS is unable to code or quantify  cancelled debts by type.
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.
section_title: IRS Challenges – Current IRS Forms Provide Limited Information on Mortgage Debt Forgiveness (cont.)
subsections: section_title: Possible changes to Form 1099-C to enhance information reporting.
section_title: Possible modifications
subsections: section_title: Box 4 could include a type of debt indicator (e.g., check boxes or codes that would disclose the
paragraphs: type of debt).
If the debt is a mortgage, lenders could report which type (e.g., acquisition,  refinance,  home  equity, etc.).
section_title: IRS Challenges – Current IRS Forms Provide Limited Information on Mortgage Debt Forgiveness (cont.)
subsections: section_title: AUR officials generally agreed that modifications to Form 982 and Form 1099-C would place little burden on IRS and taxpayers and allow IRS to better verify the type of debt and amount that can be excluded.
section_title: Objective 3: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt
paragraphs: Little concrete information exists to measure the extent to which paid  preparers and taxpayers experience difficulty adhering to mortgage debt  forgiveness provisions due to the complexity of the law, IRS forms, and  instructions.
However, anecdotal evidence suggests IRS’s forms and instructions and the  related tax laws are difficult to understand. For example: IRS officials acknowledged that the mortgage debt forgiveness law is  complex. The National Taxpayer Advocate described Form 982 as “technically  challenging.” The Center for Responsible Lending (a nonprofit organization that seeks  to eliminate abusive financial practices) characterized Form 982 as “a  very complicated and difficult form.”
section_title: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt (cont.)
subsections: section_title: Examples illustrating the complexity of Form 982 and its instructions
paragraphs: multiple types of cancelled debts are reported on Form 982 by both individuals  title of Form 982 is difficult to understand – “Reduction of Tax Attributes Due to  Discharge of Indebtedness (and Section 1082 Basis Adjustment)”;  Form 982 consists of 23 lines with four pages of instructions and includes  technical terms such as “basis reduction” and “debt discharged”; and   Form 982 instructions attempt to explain a difficult-to-understand “ordering rule”  that requires taxpayers to distinguish between qualified and nonqualified debt.
section_title: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt (cont.)
paragraphs: Revising Form 982 instructions and Publication 4681, Cancelled Debts,  Foreclosures, Repossessions, and Abandonments, to explain the requirements  for excluding forgiven mortgage debt.
Engaging in outreach to paid preparers and software providers on cancelled  debt, including providing presentations and conducting focus groups at tax  forums, and issuing press releases and other publications to clarify the tax  treatment of forgiven mortgage debt.
IRS officials said that paid preparers and software providers have asked few questions  about how forgiven mortgage debt should be treated for tax purposes.
section_title: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt (cont.)
paragraphs: IRS has not explored several options that would be relatively easy to implement and with some  additional cost could help clarify how to treat forgiven mortgage debt for tax purposes. For  example, Beginning in March 2010, IRS pilot-tested several interactive tax assistant tools on its Web  site (e.g., Child Tax Credit, and Making Work Pay Tax Credit). These tools are similar to  commercial tax preparation products. IRS officials reported that the test was successful  with a high completion rate for available issues. Further, they expect to expand the number  of interactive tools on IRS’s Web site for more complex tax law issues in the 2011 filing  season and beyond.
Although IRS developed an interactive tool for cancelled debt that is used by IRS telephone  and walk-in employees, IRS did not make the tool publicly available in 2010 because it was  not part of the pilot test.
section_title: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt (cont.)
subsections: section_title: Another low-cost option that IRS has yet to explore would involve
paragraphs: using contact analytics software (which allows IRS to analyze recorded phone  calls) to examine the reasons taxpayers call IRS with questions about forgiven  mortgage debt. IRS is in the initial stages of using contact analytics for other  purposes, and could leverage contact analytics to help understand why  taxpayers are calling about mortgage or cancelled debt.
section_title: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt (cont.)
subsections: section_title: About 90 percent of returns are prepared by individual taxpayers or paid
paragraphs: preparers using professional or commercial software.
IRS National Account Managers, through regularly scheduled conference  calls, discuss issues of mutual interest with tax software companies, including  tax law changes, updates to IRS forms and publications, and the upcoming  tax filing season.
IRS also works with software companies on an ad hoc basis to influence and  improve specific guidance provided by tax software regarding complicated tax  provisions (e.g., Earned Income Tax Credit eligibility).
section_title: Taxpayer Challenges - Complexities Exist in Reporting Forgiven Mortgage Debt (cont.)
subsections: section_title: Currently, the most frequently used commercial software packages
paragraphs: provide varying degrees of support for Form 982; although the major  software packages generally support taxpayers with relatively simple  forgiven mortgage debt situations, they provide more limited support for  more complex situations, including instances where taxpayers have  multiple forgiven debts.
Generally, these commercial software packages provide detailed interactive  questionnaires or worksheets to calculate other complicated deductions (e.g.,  what portion of a homeowner’s expenses can be deducted for using a home  office).
section_title: Conclusions
paragraphs: IRS is responsible for enforcing complex tax laws and must consider trade- offs when allocating its enforcement resources, such as the ability to collect  assessed taxes and return on investment. Deteriorating trends in the  housing market have led to an increase in the number and amount of  forgiven mortgage debts, which have complex tax consequences.  However, IRS is missing opportunities to both identify noncompliance and  assist eligible taxpayers in excluding forgiven mortgage debt before the  provision expires in 2012.
Revising the forms and using third-party information could provide IRS with more  information to determine whether taxpayers are correctly excluding forgiven mortgage debt  from income and whether IRS needs to dedicate additional resources to this issue.
Providing greater assistance to eligible taxpayers could help ensure that homeowners  understand the potential tax consequences of cancelled debts, in particular foreclosures or  mortgage modifications.
Expanding outreach efforts to external stakeholders, including software providers, could be  part of an effort to reduce common types of misreporting related to cancellation of debt  (including forgiven mortgages).
section_title: Recommendations for Executive Action
subsections: section_title: We recommend that the Commissioner of Internal Revenue take the following nine
paragraphs: actions.
To enhance IRS’s ability to detect noncompliance with mortgage debt forgiveness provisions,  1. 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; 2. 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; 3. 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; 4. 5. determine if available data (including IRS and third-party data) would allow IRS to better  identify whether the forgiven debt is for a principal residence; and  use the additional data reported on the revised Form 982 and Form 1099-C to assess the  extent to which taxpayers are compliant.
section_title: Recommendations for Executive Action
paragraphs: 6. make IRS’s interactive tool for cancelled debt publicly available for the 2011  7. use IRS’s telephone software to obtain better information about why, if at all,  taxpayers call IRS with questions about forgiven mortgage debt; 8. work with tax return preparation software companies to more fully support  complex debt cancellation issues, particularly those related to forgiven  mortgage debts; and 9. either send notices to taxpayers when a lender files a 1099-C indicating a  forgiven mortgage and the taxpayer does not file a Form 982 or document  that the costs of doing so would exceed the benefits.
section_title: Appendix II: Comments from the Department of the Treasury