Bill to Keep Loan Applicants’ Tax Returns Confidential

Home buyers and mortgage applicants nationwide could be in for an important new consumer protection from Congress: a ban against lender misuse of applicants’ confidential federal tax returns.

Tucked away in the House Ways and Means committee’s new Taxpayer Bill of Rights 2000 (House Resolution 4163) is a crackdown against a practice that threatens the privacy of many unsuspecting loan applicants’ most intimate financial information.

The bill would force lenders who obtain borrowers’ federal tax filings to keep them confidential and to make no other use of the returns beyond underwriting the mortgage.

Under current law and practice, lenders frequently ask that borrowers sign an innocuous-looking IRS document--Form 4506--at or before settlement. The form allows the lender to obtain multiple years’ worth of federal tax returns from the IRS. The purpose, say lenders, is “due diligence”: They can double-check the accuracy of information submitted by the home buyer.

The problem with Form 4506, as even the IRS admits, is that it opens a Pandora’s box. When the IRS sends private tax returns to lenders, it has no legal control over who ultimately receives the returns or how the information is used.

Lenders Free to ‘Harvest’ Data

Lenders are free to “harvest” this data into their own electronic databases and sell it to third-party marketers, private investigators, attorneys, insurance companies and others who’ll pay to examine your financial situation.

Compounding the problem is the manner in which many lenders use Form 4506. Because loans are often originated by one broker or mortgage bank and then sold later on the so-called “secondary market” to other financial entities, lenders frequently direct applicants not to fill out the form entirely.

In particular, they require applicants to leave the name of the recipient of the tax returns and the date blank. Some lenders place sticky labels covering key items of the form, reading “Leave blank.”

Take this case involving a Maryland couple who applied for a mortgage from a Baltimore-based lender. As part of the application process, the applicants were asked to submit copies of federal tax returns for their two most recent tax years.

But at the settlement table, they were asked to sign Form 4506, authorizing release of IRS transcripts not only for the two years they’d already submitted but also for two others--including the current year, which they hadn’t yet filed.

The IRS form indicated that the agency “will release the tax information requested to any party shown on line 5.” Yet the settlement agent and the lender had intentionally left line 5--the ultimate recipient of the private tax data--blank. And they insisted that the borrowers leave it blank.

Disagreement With Settlement Agent

The fine print of Form 4506 noted that the request for tax information would be valid for only 60 calendar days after the date of the mortgage applicants’ signatures. But the settlement agent instructed the couple not to date the form, saying it was the lender’s policy.

The couple refused, believing that an undated Form 4506 with the recipient’s name left blank could open their current and future federal tax returns to unknown peering eyes indefinitely.

The settlement agent, however, said the closing of the loan was “conditioned” on the couple’s agreement to execute Form 4506 the way the lender ordered. The couple had never heard of this condition until that moment and walked out of the settlement.

Asked for comment, an IRS spokesman, Don Roberts, said: “I wouldn’t sign [Form 4506] if Line 5 [the recipient’s name] is blank, and I wouldn’t sign it if it’s not dated.”

But Roberts also confirmed that under current federal law, the IRS has no control over the use of its form and no way to protect taxpayers’ privacy from abusive lenders.

The Taxpayer Bill of Rights 2000 would change that. Sponsored by Ways and Means Committee Chairman Bill Archer (R-Texas), the bill has cleared the full committee and has a good chance of becoming law this year.

Under its 4506 reform section, the bill would require lenders to guarantee the confidentiality of taxpayer information and to use it solely for the purpose requested.

The bill also directs the IRS to make the form more consumer-friendly: It will now carry a “prominently displayed” warning about the dangers of leaving key lines blank and will direct consumers on how to contact Treasury Department investigators if they believe a lender has attempted to “coerce [them] to sign an incomplete or blank form.”

Initial Reactions Are Favorable

Initial reactions from the financial industry appear favorable. Jim O’Toole, tax counsel for America’s Community Bankers, a trade group, said that though lenders “have a legitimate need to examine the credit worthiness of applicants, we certainly are not in favor of requiring customers to execute open-ended consent forms with no knowledge of who will see them or when they will be used.”

Score one for home buyers and mortgage applicants.

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Distributed by the Washington Post Writers Group.