President Obama Signs Stimulus Bill, Announces New Foreclosure Prevention Program, Treasury Department Expands TALF to Include CMBS
The month of February 2009 will undoubtedly be studied in history classes for generations to come. While it remains unclear whether the governmental action will have the desired effect of jump-starting the economy, its unprecedented nature and size ensure that it will affect numerous aspects of personal and corporate finances.
Expansion of TALF
Of particular interest to lending institutions and those involved in the commercial real estate industry is the Treasury Department's announcement that it will extend its Term Asset-Backed Loan Facility (TALF) to cover Commercial Mortgage Backed Securities and expand the scope of the program from $200 billion to possibly up to $1 trillion. The TALF program was created in late 2008 to provide a secondary market for asset backed securities (ABS) backed by auto loans, credit card debt and student loans. In order to qualify for purchase by TALF, the ABS had to be newly originated and AAA rated.
After warnings from the real estate industry about the disarray that could occur due to the estimated $400 billion in commercial mortgages coming due in 2009 and the general lack of financing available, the Treasury Department decided to expand the TALF program to include commercial mortgage-backed securities (CMBS). In order to qualify, the CMBS must be newly issued and have a AAA rating. Discussions are ongoing on the possibility of expanding the asset classes eligible to have ABS purchased through TALF. The two most likely candidates to be added are non-agency residential-backed securities (RMBS), i.e. residential mortgages not already purchased by Fannie Mae or Freddie Mac, and general corporate debt.
The logistics of making TALF funds available for CMBS purchase are expected to be made available prior to the middle of March.
The Stimulus Bill:
The American Investment and Recovery Act of 2009, commonly known as the stimulus bill, with a final price tag of $787 billion dollars, combines tax cuts and new spending programs in an effort to reinvigorate the economy and, according to President Obama, create, or prevent the loss of, up to 4 million jobs. The stimulus bill includes items designed to assist both businesses and individuals, with the majority of the assistance being aimed at low and middle-income individuals.
Tax Cuts:
Tax cuts included in the stimulus plan are aimed at both individuals and businesses, with almost all of the cuts having income/profit/revenue limits. Included in the cost of the stimulus plan is approximately $70 billion for the annual "Alternative Minimum Tax (AMT) fix", which Congress usually passes each fall to prevent middle and upper middle income individuals from being subject to a tax that was only meant to affect the ultra-wealthy.
Business Tax Relief:
Carry back of NOLs: Net operating losses, usually only allowed to be carried back two years, can now be carried back up to five years. At the taxpayer's election, this provision may be applied to losses for tax years beginning in 2008 and 2009, or tax years ending in 2008 and 2009. To be eligible for this provision, the entity must be a sole proprietorship, partnership or corporation, and its annual average gross revenue cannot have exceeded $15 million between 2006 and 2008.
Expensing of capital expenditures: Instead of booking business equipment as an asset and depreciating it, business equipment in an amount of up to $250,000 can be expensed for the year it was placed in service. The ability to expense business equipment placed in service begins to phase out if the company places more than $800,000 of business equipment in service during the year (the same phase out amount as 2008). The extension of the ability to expense capital expenditures up to $250,000 lasts only for 2009. After 2009, the amount of business equipment that can be booked as capital expenditures reverts to the pre-2008 level of $125,000.
Affordable housing: Gap financing of $2.25 billion dollars will be made available to state housing credit agencies until September 30, 2011. Funds from this program will only be available to owners who have previously received an award of low-income housing tax credits or simultaneously receive the award. The award can be in the form of an allocation of credits from the applicable state housing credit agency or as a result of the use of tax-exempt bond financing for the project. Of this amount, 75% must be committed by housing credit agencies within one year of enactment and expended by owners within two years of enactment. The total amount of the funds must be expended within three years from enactment, and states must give priority to projects that are expected to be completed within this time frame. Any funds not expended within the three year time period will be re-distributed to states that have fully utilized their funds. In addition to the gap financing, the stimulus package authorizes the Treasury Department to make a grant to each State housing credit agency, at the agency's election, of up to 85% of a housing credit agency's low-income housing tax credit allocations in exchange for the "return" of such credits, subject to a maximum amount of credits per agency that may be "returned".1 If a housing agency does not use its exchanged funds prior to January 1, 2011, the funds must be returned to the Treasury Department. This exchange is only available for 2009.
"Bonus" depreciation extended: A 50% "bonus" depreciation, which was only intended to run through the end of 2008, will now run through all of 2009 as well. This bonus depreciation is available for a wide range of assets, including property with a modified accelerated cost recovery system (MACRS) recovery period of 20 years or less, water utility property, certain computer software, and qualified leasehold improvement property. As in 2008, the option to forego the bonus depreciation and instead take historic AMT or research and development (R&D) credits remains.
Spreading out cancellation of debt (COD) income: When a debtor's outstanding indebtedness is reacquired by the debtor (or by a person related to the debtor) at a discount, the debtor is deemed to have income in the amount of the discount. For discharges of debt occurring in 2009 and 2010 resulting from any such reacquisition of outstanding indebtedness, instead of realizing the income immediately, the taxpayer can choose to spread out the income over a five-year period beginning in 2014. This provision only applies to COD income resulting from repurchases of debt instruments (i.e., debt for debt (including debt modifications), debt for equity, debt for partnership interests, or capital contributions). There are limitations on combining this deferral and other available exceptions, and the taxpayer must recognize the entire amount of the COD income immediately upon the sale of the debtor's business and other listed circumstances.
Increase of gain exclusion on small business stock: Prior to the stimulus bill, gains realized on small business stock held at least five years were subject to a 50% exclusion, if certain other conditions were met. For small business stock issued between February 17, 2009 and December 31, 2010, the exclusion is increased to 75%. As in previous years, the exclusion only applies to individual taxpayers and is limited to ten times a taxpayer's basis in the stock or $10 million. As a general rule, to qualify, the subject business must have less than $50 million in assets.
S Corps. get a reprieve: Appreciation in value of assets held when a C Corp. elects S Corp. status is normally subject to corporate (double) taxation to the extent recognized in the 10 year period after the election. For 2009 and 2010, the stimulus package adjusts this period to seven years, so if the S. Corp. election was more than seven years ago, there will be no corporate tax on 2009 and 2010 sales of assets which were held when S Corp. election was made.
Individual Tax Relief:
Reduction in estimated taxes for owners of small businesses: Individuals who own small businesses are generally required to make estimated quarterly tax payments (based on the required annual payment) to the extent that tax is not collected through withholding. For taxpayers with adjusted gross income (AGI) of $150,000 or more, the required annual payment was the lesser of 90% of the tax shown on the return or 110% of the tax shown on the return for the prior year (underpayment, with certain exceptions, results in a penalty).2 Under the stimulus bill, a qualified individual's required annual payment is the lesser of 90% of the tax shown on the return or 90% of the tax shown on the taxpayer's return from the prior year. A person is a qualified individual if the person's AGI is less than $500,000 ($250,000 if married filing separately) and the taxpayer certifies that at least 50% of the income shown on their return for the prior year was from a small trade or business. To qualify as a small trade or business, the trade or business cannot have employed an average of more than 500 people in the preceding tax year. The effect of this change in the tax code is that small business owners who are qualified individuals may be able to make lower estimated quarterly tax payments for 2009.
Deduction of sales tax on new vehicle purchase: Individuals who purchase a new 2008 or 2009 vehicle after February 17, 2009 and prior to January 1, 2010 will be able to deduct the sales tax paid on the vehicle. The deduction is above the line, so even individuals who do not itemize will still be eligible. The deduction phases out beginning at a modified adjusted gross income level of $125,000 ($250,000 if married filing jointly) and is fully phased out at $135,000 ($260,000 if married filing jointly). If the vehicle purchased is in excess of $49,500, only the sales tax paid on the first $49,500 may be deducted.
First time homebuyer credit: First time homebuyers will be eligible for a credit of 10% of the purchase price of the home (up to $8,000), if the purchase is made from January 1, 2009 through November 30, 2009.3 The credit is subject to a phase out beginning at a modified adjusted gross income level of $75,000 ($150,000 if married filing jointly) and is fully phased out at $95,000 ($170,000 if married filing jointly). Unlike the $7,500 "credit" for first time homebuyers unveiled last summer, which was actually an interest free loan, the new credit will not have to be repaid so long as the homeowner owns and occupies the home and is their principal residence for at least three years after the date of purchase.
Energy efficiency credit: In prior years, qualifying residential improvements which improved the energy efficiency of a dwelling were eligible for a credit of 10% of the cost of the upgrade, with each taxpayer being subject to a $500 lifetime maximum. Under the stimulus plan, the credit is extended until December 31, 2010, and the taxpayer is entitled to a credit equal to 30% of the upgrade, up to a lifetime maximum of $1,500 (after December 31, 2010, the lifetime maximum reverts to $500). The list of improvements that qualify includes, but is not limited to, highly-rated insulation, new windows, central air conditioners, water heaters and furnaces. The energy-efficiency standards of qualifying property are also updated.
Education expenses: Previously, distributions from qualified tax advantaged tuition programs could not be used to pay technology expenses. For 2009 and 2010, the definition of education expenses has been expanded to include computers, computer technology, and internet access (software for sports, games or hobbies is not included, unless the software is predominantly educational in nature). Additionally, students or their parents are eligible for tax credits of up to $2,500 to help pay tuition and other education expenses for 2009 and 2010.
Spending:
Along with one of the largest tax cut programs in American history, the stimulus plan also includes a massive jolt of spending. While the details of the spending program are too numerous to list (as well as being readily available online), some of the highlights include:
Infrastructure: The stimulus bill commits $90 billion to payments for infrastructure, including repair of existing roads, bridges and water systems. Also included will be the construction and upgrading of mass transit systems.
Energy: The stimulus bill includes approximately $20 billion to help create "green jobs." The money is going to be spent through a combination of loan guarantees and grants. Additionally, $11 billion will be spent to modernize the nation's power grid with so-called "smart grid" technology and $2 billion invested in battery research for future electric cars.
Education: $54 billion will be dedicated to schools. Some of the money can be used to modernize/renovate schools and colleges, though the exact amount is not clear. Additionally, $25 billion is going to be spent on No Child Left Behind and special education programs. Another $4 billion is marked for Head Start, Early Head Start and other child care programs. Finally, $32 billion will be spent on higher education, with about half that amount marked for scientific research and the majority of the rest used to increase the maximum amount of Pell Grants and increase the number of students eligible to receive Pell Grants.
Environment: The Interior Department and the EPA will receive $9.2 billion for environmental projects and repair and maintenance of national parks. The money will be used by the EPA for a variety of clean-up programs.
Residential Foreclosure Prevention Program
The foreclosure prevention program is comprised of three separate programs: (1) a program to allow those without 20% equity in their homes to refinance at the current rates; (2) a program to lower the monthly payments of those behind in their mortgage payments or in danger of becoming behind in their mortgage payments to 31% of income; and (3) additional financial support of Fannie Mae and Freddie Mac.
Refinance: This program is meant to address those who would like to refinance, but, due to the decline in home values, do not have the required equity in their house (usually 20%). In the example given by the administration, a family with a 30 year fixed rate mortgage of $200,000 (with an original principal balance of $207,000) and an interest rate of 6.5% would save over $2,300 if they could refinance to a rate near 5.16%.4
To be eligible to refinance through the new government program, the following criteria must be met:
- The loan must be a loan owned or securitized by Fannie Mae or Freddie Mac;
- The property must be owner occupied;
- The first mortgage must not exceed 105% of the current market value of the property;
- The borrower must have sufficient income to support the new mortgage debt; and
- The borrower is not currently delinquent on their mortgage.
If there are secondary liens on the property, the borrower will still be eligible if the above criteria are met and all junior lien holders agree to subordinate to the new first mortgage.
Lowering of Payments: The government will spend $75 billion to lower payment amounts for those already in default, or those in danger of defaulting on their mortgages. The goal of the program will be to lower the amount of the payment the mortgagor is making to 31% of the mortgagor's household income. To accomplish this, the government is requiring participating lenders to lower the monthly payments to 38% of the mortgagor's household income. The government will then split the difference with the mortgagee to lower the payment amount so that it is 31% of the mortgagor's household income. The reduction can take place through a lowering of the interest rate, a reduction in principal, or a lengthening of the term of the mortgage. The following are the steps which servicers must take to reduce the payment (after determining eligibility and setting a target payment):
Step 1: Reduce the interest rate (subject to a floor of 2%). If it is not possible to reach a debt to income (DTI) rate of 31% by reducing the interest rate (subject to the floor), go to step two. If the interest rate reached under this step is greater than the interest rate cap5, this will be the interest rate for the remainder of the loan. If the interest rate reached is less than the interest rate cap, the interest rate reached under this step will be the interest rate for five years, followed by annual increases of 1% per year until the interest rate matches the interest rate cap, which will then be the interest rate for the remainder of the loan.
Step 2: Extend the term of the loan up to 40 years. If extension of the term of the loan is not permitted, the amortization should be extended. The extended period would start on the modification date, not the loan's original funding date. If DTI cannot be reduced to 31% by extension of the loan term or amortization, then the servicer would proceed to Step 3.
Step 3: Forbear principal. The servicer would treat the loan, and interest would be due, as if the loan were for a lower amount, though there would not be any forgiveness of that amount. If there is a principal forbearance, a balloon payment of the forborne principal would be due upon the earlier of: (1) the sale of the property, (2) the maturity date of the loan (as may be extended), or (3) payoff of the interest bearing balance.
To encourage servicers, lenders and borrowers to participate, the program provides the following incentives:
Servicers: Will receive an up-front fee of $1,000 for each eligible modification meeting the plans guidelines. Servicers will also receive a fee of $1,000 for each year, up to three years, that the borrower stays current under the modified loan. An additional one time payment of $500 will be made to servicers if the modification is of a borrower who is current on their mortgage, but is at risk of imminent default.
Lenders: Will receive a one time payment of $1,500 for each modification made to a borrower who is current on their mortgage, but who is at risk of imminent default. Additionally, the Treasury Department will establish a fund of up to $10 billion to provide a cushion against future losses on modified loans. The $10 billion will come from TARP funds, as will the majority (but not all) of the remainder of the $75 billion.
Borrowers: In addition to the lower monthly payments, each borrower will be credited with $1,000 per year for each year the borrower remains current on the modified loan, up to a maximum of five years. This amount will be a principal reduction on the amount owed.
Not all borrowers will be eligible to participate in the payment reduction program. The following are the criteria.
- The loan must have been originated on or before January 1, 2009.
- The unpaid principal balance of the loan must be equal to or less than $729,750. (higher limits apply for two through four family dwellings). Capitalization of arrearages is not considered in determining the unpaid principal balance for purposes of eligibility.
- If a borrower has "back end" debt (mortgage, car, credit cards, etc.) equal to or greater than 55% of the borrower's income, the borrower must agree to enter a debt counseling program as a condition of the modification.
- The home that is the subject of the modified mortgage must be owner occupied.
- All borrowers must fully document income, which includes signing IRS form 4506-T (request for copy of tax return), and must sign an affidavit of financial hardship.
Servicers must enter into the program on or before December 31, 2009. New borrowers will be accepted into the program until December 31, 2012 (subject to the above qualifications). Compliance with the program will be audited by Freddie Mac.
Strengthening the GSEs:
In an effort to support lower rate mortgages and ensure the financial viability of Fannie Mae and Freddie Mac, the Treasury Department is taking the following actions:
- Increasing its Preferred Stock Purchase Agreements by $100 billion each (from $100 billion to $200 billion per entity).
- Continuing to purchase Freddie and Fannie mortgage backed securities.
- Increasing the size of the government-sponsored enterprises (GSEs) retained mortgage portfolio allowed, by $50 billion to $900 billion.
In addition to the carrots provided to all parties to attempt to effectuate an increase in mortgage modifications, the administration's announcement comes with a large stick. The administration has announced more forceful support of legislation that would allow bankruptcy judges to "cram down" mortgages. Giving bankruptcy judges this additional power will require congressional action modifying the bankruptcy code.
How any of the programs mentioned in this Alert affect an individual, company, or transaction will require detailed analysis of the particular facts and circumstances surrounding that individual, company or transaction. We send these newsletters to our clients and friends, free of charge, to share our thoughts on new developments in the law. Nothing in this newsletter should be relied upon as legal advice in any particular matter. If you have any questions on how the topics discussed in this Alert affect you, please contact Riker Danzig's Tax or Real Estate Group.
1 The formula takes into account the amount of the tax credit received by the state, the amount of national pool credit, and the unallocated/unused portion of the State's 2008 and 2009 credits.
2 If the taxpayer's AGI was under $150,000, the required annual payment is the lesser of 90% of the taxes shown on the return or 100% of the tax shown on the return for the prior year.
3 In order to be eligible for the credit, the transaction must close between these dates.
4 The figure given by the administration does not take into account the extra taxes the family would presumably pay due to a decreased mortgage interest deduction.
5 The interest rate cap is the lesser of (i) the fully indexed and fully amortizing original contractual rate or (ii) the Freddie Mac Primary Mortgage Market Survey rate for 30-year fixed rate conforming mortgage loans, rounded to the nearest .125%, as of the date that the modification document is prepared.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
