The Internal Revenue Service could collect more taxes from forgiven mortgage debt by expanding its information reporting and revising some of its forms, according to a new study from the General Accountability Office.
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IRS estimates suggest the dollar amount of forgiven mortgage debt excluded from income could be significant, said the report.
IRS Statistics of Income officials estimate that for tax year 2008, the most current tax year for which data is 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. The 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.
In addition, 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, the IRS lacks the data to determine the dollar amount of forgiven mortgage debt excluded for these taxpayers.
The IRS faces several compliance challenges in administering this complicated tax provision, the GAO noted. 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 the IRS's return on investment, would affect the IRS's decisions about allocating resources for enforcing this provision.
However, the GAO said there is evidence that 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 five 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 the 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, the IRS cannot determine what dollar amounts are being excluded for each type of qualified canceled debt.
The instructions for Form 1099-C ask lenders to provide an open-ended description of the type of canceled debt, but do not require the lender to uniformly identify the specific type of canceled 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 canceled 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 the IRS to better determine whether the forgiven debt is for a principal residence.
The GAO previously recommended that the 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. The IRS agreed to study the issue.
Without being able to systematically identify whether the forgiven debt is for a mortgage, the GAO said the IRS also cannot identify taxpayers who may be eligible for the provision, but are not taking advantage of it.
The GAO found that the IRS is not using available internal or third-party data to determine whether taxpayers with forgiven mortgage debt own multiple homes, which is also a potential indicator that the forgiven debt is not for a principal residence.
The GAO recommended that the IRS modify Form 982, Part 1, to segregate the total dollar amount of forgiven debt by exclusion type and capture the information in the IRSs databases; and modify Form 1099-C to require lenders to identify in a more usable format (check boxes or coding, for example) the specific type of canceled debt and capture the information in the IRSs databases. The IRS should also modify 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 the IRSs databases; determine if the available data (including IRS and third-party data) would allow the IRS to better identify whether the debt being excluded 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.
To provide better information for paid preparers and taxpayers to determine the eligibility for excluding forgiven mortgage debt from taxable income, the GAO said the IRS should also explore and implement readily available low-cost options to help clarify the tax treatment of forgiven debt, including options such as making the IRSs interactive tool for canceled debt publicly available for the 2011 filing season. The agency should also use the IRSs telephone software to obtain better information about why, if at all, taxpayers call the IRS with questions about forgiven mortgage debt; work with software companies to more fully support complex debt cancellation issues, particularly those related to forgiven mortgage debts; and 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.
IRS deputy commissioner of services and enforcement Steven T. Miller agreed with many of the GAOs recommendations in his response to the report, but noted that there is currently little data available upon which the IRS can measure the extent to which taxpayers and paid return preparers experience difficulty in complying with the debt forgiveness provisions of the Tax Code.