NYT: Gentler Tax Laws Urged on Debt Default

By LYNNLEY BROWNING
Published: January 7, 2009

Congress should ease certain tax laws governing defaults on mortgages, credit cards and other consumer debt to help Americans who are struggling in the economic downturn, the watchdog agency of the Internal Revenue Service said Wednesday.

In its annual written report, the agency, the National Taxpayer Advocate, said that without the changes hundreds of thousands of Americans could mistakenly pay taxes this year on their canceled debts, adding to their financial malaise.

The I.R.S. generally treats canceled debts as subject to federal income tax unless the taxpayer is insolvent or in bankruptcy proceedings.

But Nina E. Olson, who leads the watchdog agency, wrote that most taxpayers eligible to exclude canceled debts from their overall taxable income were unaware that they must file an obscure, complex form with the I.R.S.

She called on Congress to change the law to exempt taxpayers with what she termed “modest” amounts of canceled debt from having to submit the form. She did not put a dollar limit on the amounts and instead asked Congress to establish a threshold.

Congress has already provided some debt relief to homeowners through the Mortgage Forgiveness Debt Relief Act of 2007, which exempts from taxes any debts reduced or canceled during foreclosure or mortgage restructuring. But the exemption applies only if proceeds are used to acquire or improve a principal residence — something home buyers do not always do.

“It appears that most subprime borrowers use a portion of their loans for other purposes (e.g., to pay off car loans, credit card balances, student loans or medical bills),” Ms. Olson wrote.

She issued her report amid a flurry of unusual activity by the I.R.S. to award tax breaks to banks and financial corporations. The breaks, which give banks more leeway to use tax losses from banks they acquire, are estimated by leading tax specialists to be worth at least $110 billion.

Ms. Olson, referring to the economic downturn, also called on the I.R.S. to ease harsh collection practices. Levies, liens and asset seizures — all increasingly used tools of the I.R.S. — should give way to installment agreements with taxpayers and deals known as “offers in compromise,” in which taxpayers offer to pay part of their tax debts.

While I.R.S. staff members are required by law and internal procedures to consider whether collection efforts impose an economic hardship on taxpayers, they often do not do so, Ms. Olson wrote.

She urged the I.R.S. to protect low-income Social Security recipients from automated tax levies, which typically total 15 percent of the federal payments they receive.

In 2008, the I.R.S. issued levies against 1.8 million payments made to Social Security recipients. More than a fourth of those taxpayers had incomes below the poverty level, and more than a third probably would be classified as unable to pay by the I.R.S. if their cases were subject to human review.

Ms. Olson also called on Congress to simplify the tax code radically, an issue she identified as the leading challenge to taxpayers, and one that has appeared frequently in her annual reports.

Copyright 2008 The New York Times Company. All rights reserved.