The IRS has excluded pay-for-performance success payments made under the federal government’s new Home Affordable Modification Program from counting as income.

The IRS said in Revenue Ruling 2009-19 that the payments are excludable from income under the general welfare exclusion.

“The deep contraction in the economy and in the housing market has created stress for homeowners throughout the country,” said the IRS ruling. “Large numbers of homeowners are struggling to afford their current monthly mortgage payments and are at risk of losing their homes.”

In response, the federal government introduced the Homeowner Affordability and Stability Plan to help at-risk homeowners modify their mortgages to avoid foreclosure. HAMP, a key component of the plan, helps homeowners who have defaulted, or are at risk of default, on their mortgages because, for example, they are suffering serious hardships, decreases in income, increases in expenses, and high mortgage debt compared to monthly income.

Under HAMP, homeowners that make timely payments on their modified loans are eligible to have incentive payments made on their behalf to lenders and investors. Each month that a homeowner makes a mortgage payment on time, the homeowner accrues an amount toward a pay-for-performance success payment. A payment of the accrued amounts is made annually, to reduce the principal balance on the homeowner’s mortgage loan.

Homeowners can receive principal reductions of up to $1,000 per year for up to five years, subject to a de minimis threshold.

Section 61(a) of the Tax Code provides that, except as otherwise provided by law, gross income means all income from whatever source derived. Payments under governmental social benefit programs for the promotion of the general welfare and not for services rendered, however, are not includible in a recipient’s gross income. This is known as the general welfare exclusion.

The IRS said the pay-for-performance success payments made under the Home Affordable Modification Program promote the general welfare by helping homeowners who are at risk of losing their homes pay the mortgage loans on their primary residences and do not involve the performance of services. Thus, the payments meet the requirements of the general welfare exclusion.

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