With lawmakers showing little enthusiasm for an ambitious proposal by House Ways and Means Committee Chairman Dave Camp (R-Mich.) to overhaul the byzantine U.S. tax code, Congress has to decide what to do about dozens of temporary tax breaks that expired Dec. 31. Among them is an exemption for forgiven mortgage debt that's an essential part of a broader federal effort to solve a nagging problem, namely the spate of defaults caused by the recession. Failing to renew it would cripple efforts by government and banks to mitigate the damage caused by the housing crisis.
This page has repeatedly endorsed the idea of a simpler tax code that broadens the base by thinning the thicket of deductions, exemptions, credits and preferences. Nevertheless, some tax breaks, such as the credit for spending on research and development, are worth keeping because they promote the investments needed to sustain growth over the long term. And other, temporary carve-outs can be an essential part of the government's response to the crisis du jour.
Such is the case with the exemption for forgiven debt on a residential mortgage. Facing a destructive wave of foreclosures, federal and state officials have pressured banks to help troubled borrowers by writing off a portion of their debt. But the Internal Revenue Service considered every dollar of debt forgiven in a mortgage modification the same as a dollar of taxable income, a rule that threatened to make such modifications unaffordable for struggling borrowers. So Congress temporarily waived the tax on forgiven mortgage debt, starting in 2007.
The waiver expired — prematurely— at the end of last year. Although foreclosures have dropped to near pre-recession levels nationally, scattered communities continue to struggle with mortgages failing at double-digit rates. That's why regulators continue to strike deals with banks and mortgage service companies that compel them to forgive billions of dollars in mortgage debt. It makes no sense to have the IRS crushing the same borrowers that the government is trying to save, especially when lenders and neighboring property owners also have a strong interest in averting foreclosures.
The Senate Finance Committee has approved a bill that would extend the exemption for two years, as well as renewing dozens of other temporary tax breaks. Camp, however, has said he wants to renew only the handful of those breaks that he believes should be made permanent, such as the R&D; credit. Such a blinkered approach threatens to hurt thousands of troubled borrowers who could qualify for modified mortgages with less debt, as well as the lenders that would be better off modifying their loans than foreclosing on them. As long as the government and lenders are making extraordinary efforts to reduce foreclosures, lawmakers should make sure that the IRS stays out of the way.