Two new laws provide tax breaks

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by Brian C. Bernhardt

Competing forces resulted in the creation of two taxpayer friendly laws at the end of 2007.  On the one hand, the housing slump and sub-prime mortgage lending crisis have caused substantial financial difficulties for many people. On the other hand, strong gains in the securities markets over the past two years have resulted in an increase in wealth for many people. Both of these forces, however, could have caused large parts of the population to pay higher taxes in 2007. In recent weeks, however, Congress and the president enacted the Mortgage Forgiveness Debt Relief Act of 2007 and the Temporary Tax Relief Act of 2007 to avoid these tax increases.

The Mortgage Forgiveness Debt Relief Act eliminates taxes associated with “phantom income.”  Homeowners earn phantom income when they either default on their mortgage and the mortgage holder sells the home, or when they renegotiate their mortgage. In both cases, the homeowner will eliminate or decrease the amount of money they owe on the mortgage. Tax rules require homeowners to treat this decrease in debt as income. As a result, homeowners end up owning taxes on income they never received.

The Mortgage Forgiveness Debt Relief Act prevents the IRS from imposing taxes on any phantom income homeowners receive in 2007, 2008, or 2009 because of a mortgage foreclosure or renegotiation. 

The Mortgage Forgiveness Debt Relief Act has an additional useful provision.  In recent years, taxpayers who itemize their deduction have been able to deduct private mortgage insurance they pay on their mortgages. Congress created this tax benefit during the housing boom to encourage lending to potential homeowners. In the Mortgage Forgiveness Debt Relief Act, Congress extended this deduction for three years.

The Temporary Tax Relief Act eliminates the potential impact of the alternative minimum tax (the “AMT”) for many taxpayers in 2007. Congress originally enacted the AMT in 1969 to ensure that the wealthiest Americans could not avoid paying taxes by taking advantage of deductions and loopholes in the tax code. Unfortunately, Congress did not index the AMT for inflation. As a result, every year more and more Americans become subject to the AMT, which eliminates a variety of tax deductions and results in increased taxes. Without the Temporary Tax Relief Act, approximately 20 million additional taxpayers, some making less than $50,000 per year, would be subject to the AMT. The Temporary Tax Relief Act increases the amount of income taxpayers must earn to be subject to the AMT. As a result, the AMT will affect fewer low and middle income taxpayers in 2007.

This year, Congress has given taxpayers a Christmas present of three favorable tax provisions.  Unfortunately, none of the three is permanent, and Congress will need to revisit the AMT in 2008.  Enjoy these gifts now, while you still can — tax relief is often a painful and slow process, and an election year like 2008 promises to make it even more so.

Brian Bernhardt is a partner in the Richmond office of McGuireWoods LLP. He practices in the areas of Federal tax controversies, Federal tax litigation, and nonprofit and tax-exempt organizations, focusing on their administrative relationships with the Internal Revenue Service. 

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