North Carolina lawmakers are poised to renew a rule requiring homeowners to pay state income taxes on mortgage debt forgiven by lenders – a move that could cost some homeowners thousands of dollars in additional taxes.
For years, North Carolina allowed taxpayers not to count written-off mortgage debt as taxable income after Congress, responding to the mortgage crisis, enacted a similar exclusion on federal income taxes.
In 2013, North Carolina took away the exclusion for the first time since the crisis. And last week the N.C. Senate passed a bill that would not allow the exclusion for tax year 2014. The House is expected to vote on the measure this week.
To illustrate what the bill would mean, if a homeowner received $20,000 in mortgage principal forgiveness, he or she would have to pay $1,160 in additional taxes, based on the state’s individual income tax rate of 5.8 percent. If $40,000 were forgiven, he or she would owe $2,320 in additional taxes.
Analysts say the proposal, which is included in a bill changing the state’s gasoline tax, could affect as many as 4,000 N.C. homeowners caught up in the mortgage crisis.
Republican and Democratic lawmakers are divided on the proposal, which General Assembly staffers estimate will bring in about $14 million in 2014 tax revenue.
Republicans say the move would be consistent with other tax changes that have lowered rates and eliminated many deductions.
But Democrats and some consumer advocates say it would hurt homeowners struggling to recover after falling into foreclosure and defeat the purpose of a lender providing the debt relief in the first place.
“This is not a good policy,” said Al Ripley, director of consumer and housing affairs for the North Carolina Justice Center. “We want to try to create situations where they will be able to afford to stay in their house … not engage in policies that will take resources away from those families and make it more likely that they will end up in foreclosure or face other economic hardship.”
Taxpayers can still claim the exclusion on 2014 federal income taxes after President Barack Obama signed an extension in December. The exclusion stems from the Mortgage Debt Relief Act of 2007.
As recently as two years ago, North Carolina was one of seven states not allowing taxpayers to exclude canceled mortgage debt from taxable income, according to a study by H&R Block.
The N.C. Department of Revenue said it is still compiling data for tax year 2013 and does not know how much additional tax revenue the state collected on canceled mortgage debt that year.
The proposal to not allow the exclusion prompted a passionate debate in the N.C. Senate on Thursday. Among other tax changes in the bill is the loss of a taxpayers’ deduction of college tuition expenses.
Together, the changes are expected to mean an additional $73 million in state revenue.
Republican Sen. Harry Brown of Onslow County said not having that revenue would hurt working families.
“What you’re talking about is 70-some million of revenue that the state would have to come up with …” said Brown, co-chair of the Senate Appropriations Committee. “Are you going to take it from teachers? … Or Health and Human Services? Or the court system? That should be part of the argument.”
Senate Finance Committee Chairman Bob Rucho, a Matthews Republican, said lawmakers are seeking the changes to be consistent with other tax changes that have lowered rates and eliminated many deductions.
“We just feel like consistency is important,” Brown said later. “It’s pretty much aligned with our tax reform. We think driving the rates down will serve (the middle class) in the long run.”
But Senate Minority Leader Dan Blue of Raleigh said the bill means that “we kick people while they’re down.
“If they had money they wouldn’t be in foreclosure,” he told colleagues. “What we’re doing is saying you have to come up with money because you managed to get the mortgage company to forgive this loan. You’re wrapping something around their neck probably for the rest of their lives.”
Democratic Sen. Joel Ford of Charlotte said in a $21 billion state budget, Republicans could make up for the revenue elsewhere.
“We just need to prioritize working families rather than corporations and special interests,” he said. “You mean to tell me you folks can’t find ($73 million) for the working families of North Carolina? If you can’t find it you should be ashamed of yourselves.”
Bart Hildreth, executive director for the Washington, D.C.-based National Tax Association, said it’s appropriate for state legislatures to take a second look at tax policies, such as those put in place in response to the mortgage crisis.
“Policy experts typically recommend that states revisit each of those periodically to see if they’re still meeting public policy goals,” he said. “You don’t want it all to be on autopilot.”
N.C. foreclosures still high
The proposal comes at a time when foreclosure activity in North Carolina and Charlotte remains higher than in much of the U.S.
According to a report released Thursday by data firm RealtyTrac, one in every 711 housing units in the Charlotte region had a foreclosure filing in January, the 35th-highest rate in the U.S. among 213 metro areas. North Carolina posted the 14th-highest rate: one filing for every 1,044 housing units.
The proposal also comes as Bank of America is just starting to provide $7 billion in consumer relief nationwide as part of its $17 billion settlement with the U.S. government announced last year. Some of that relief is expected to take the form of principal reductions on mortgage loans.
Bank of America spokesman Dan Frahm said the bank has forgiven more than $164 million in principal on 3,600 home loans in North Carolina since 2008. The average amount forgiven over that period is nearly $45,000, he said.
Jason McGrath, a Charlotte-based attorney who works with clients dealing with mortgage disputes and foreclosures, said that while foreclosure activity is falling nationwide and locally, many homeowners are still fighting to keep their homes.
“My firm is as busy as we have ever been with regard to those kinds of cases,” he said. “The overall numbers may be down, but it’s still very much an ongoing issue.”
He said some homeowners might pass up an offer of mortgage relief that could give them much-needed assistance because of the increase in taxes the homeowners might have to pay later.
“It certainly can be part of a self-defeating process” to forgive mortgage debt only to tax consumers on that aid, “smacking them on the back end.”