Here are details about three tax provisions in the Emergency Economic Stabilization Act of 2008, which was signed into law on Oct. 3, 2008.
Those provisions are:
(1) a three-year extension of income tax relief when home mortgage debt is forgiven,
(2) tax relief for community banks that invested in Fannie Mae and Freddie Mac preferred stock, and
(3) a tax crackdown on compensation and severance pay for certain executives of financial companies.
Three-year extension of home mortgage debt forgiveness relief. The new law provides assistance to homeowners who have either lost their homes to foreclosure or are trying to save their homes by restructuring their mortgages. Under 2007 tax legislation, taxpayers can generally exclude up to $2 million of mortgage debt forgiveness on their main home. This relief provision had been scheduled to expire at the end of 2009. The new law extends this debt relief provision through the end of 2012.
To understand the importance of this relief provision, one needs to know that a discharge of indebtedness—that is, a forgiveness of debt— generally gives rise to taxable income. Under the law that applied to debt discharges before 2007, there were no special rules applicable to discharges of mortgage debt on the taxpayer's main home.
For example, assume a taxpayer who wasn't in bankruptcy or insolvent owned a main home subject to a $200,000 mortgage debt for which the taxpayer was personally liable. The creditor foreclosed and the home was sold for $180,000 in satisfaction of the debt. If this scenario had occurred in 2006, the debtor would have had $20,000 of debt discharge income. The result would have been the same if the creditor had restructured the loan and reduced the principal amount to $180,000.
Effective for discharges on or after Jan. 1, 2007, the tax law was temporarily changed to allow taxpayers to exclude up to $2 million of mortgage debt forgiveness on their main home. The exclusion applies to debt used to acquire, construct, or substantially improve the taxpayer's main home and secured by that home. Refinanced debt is eligible for the exclusion up to the amount of the old mortgage principal just before the refinancing.
Assume in the example provided above that the discharge occurred in 2007 instead of 2006. In that case, the debtor would have no debt discharge income when the creditor (1) foreclosed with the result that the $200,000 debt was satisfied for $180,000 or (2) restructured the loan and reduced the principal amount to $180,000.
However, this debt relief provision was scheduled to expire at the end of 2009. The new legislation extends the provision through 2012. Apart from providing this three-year extension, no other changes were made to the provision.
Tax relief for banks. Many banks had huge losses on their Fannie Mae and Freddie Mac preferred stock holdings which became worthless when the government bailed those companies out. Without a tax change, these banks would have had capital losses on these holdings that they couldn't utilize. The new legislation allows banks (and certain other financial institutions) to treat losses on their Fannie Mae and Freddie Mac preferred stock as ordinary losses that can offset ordinary income. This provision, which applies to any preferred stock that was owned on Sept. 6, 2008, or sold between Jan. 1, 2008, and Sept. 6, 2008, allows banks to claim the book benefit of the loss on their tax returns, thereby reducing their need to obtain additional capital from the FDIC or investors.
Tax crackdown on compensation and severance pay for certain financial executives. Under the new law, when a company sells assets to the Treasury through an auction, and the total of assets purchased from the company exceeds $300 million (including direct purchases), (1) “golden parachute” payments are banned for top executives hired while the Treasury rescue is in effect and (2) tax provisions kick in to strengthen the tax treatment of remaining executive compensation and severance packages.
Specifically, the deductibility of executive compensation for companies will be cut in half from pre-Act levels, from $1 million to $500,000. Companies won't be able to get around this limit by giving their executives “performance-based compensation,” such as stock options.
Companies will also lose deductions available under pre-Act law for excessively large severance packages. Executives receiving severance packages will continue to face a 20% excise tax on payments once they reach a certain threshold. That tax will be due if the executive is fired or leaves in connection with the employer's bankruptcy, liquidation, or receivership—not just if the company changes hands, as under pre-Act law.
We hope this information is helpful. If you would like more details about these changes, or any other aspects of the new law, please do not hesitate to call.
Very truly yours,
Cohen & Grieb, P.A.
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