Lessons in Foreclosure: The Aftermath of a 1099-C

     Originally published in the NV and CA Examiner 10/29/2010 issue

     While we are witnesses to the millions of homes that were foreclosed in the past two years all across the country, we anticipate that there will still be millions that will be foreclosed in the near future. Even if there was temporary halt of foreclosures about two weeks ago, as Attorneys  general from all 50 states launched a joint investigation into allegations that mortgage-servicing companies submitted fraudulent documents and broke laws in foreclosure proceedings, the freeze has now thawed and foreclosures will now proceed as planned or scheduled.  For some observers, they say that a Foreclosure Moratorium is actually a bad idea. For starters, it will not address the underlying issue that thousands of homeowners can’t make their mortgage payments. According to Barbara Novick, Vice-Chairman of Black Rock Investment Management, “postponing the resolution of these debts will actually prevent consumers from extricating themselves from loans they can’t afford. Worse, a national foreclosure moratorium will exacerbate the housing-market crisis and prevent supply and demand from ever reaching its equilibrium.”

      Indeed, the topic of foreclosure, whether in the investment world or the tax world, is still very hot and does qualify to be referred to as the “talk of the town.” In my book, it will do well for all tax practitioners to equip and arm themselves with this knowledge so that they are able understand it themselves and eloquently relay it to their clientele. Las Vegas, and maybe some parts of California, could be a place or two, where probably two out of every five homeowners had been or is going through foreclosure. The stats from my readings reveal that almost half of all homeowners all around the country where they are “upside down” or “underwater” in their mortgages are all candidates for foreclosures.

     So let’s get some eye-openers here as we learn some lessons in foreclosures. But before I discuss the implications of foreclosures, let me give you a bird’s eye view of what foreclosure can mean to an individual who has not yet consulted an Enrolled Agent or a licensed tax professional in this issue.

     Foreclosure is one of the most negative, if not the most negative, items in our credit report. They say it can affect one’s credit score by more than 300 points. A foreclosure will remain on our credit report for as long as ten years and is permanent in the public records of the county in which the property is located. Present and future employment can also be affected by foreclosure since employers have the right to check one’s credit, especially those who are in very sensitive job positions.

     So when does foreclosure begin and when does it end? Well, normally a foreclosure begins its process when the homeowner decides to stop making payment on his or her mortgage. Surely there are valid reasons from the side of the homeowner, such as decrease in income due to unemployment or business failures, etc., why they have decided to stop making payments. However, in a depressed housing market, such as what we have right now, one reason stands out: The property has lost its value.

     After the homeowner had been bombarded with letters of default, the mortgage company will soon foreclose on the property. And after the foreclosure proceedings, the homeowners try to piece their lives together or whatever is left of it. The fact is, majority of them don’t really know what lies ahead of them.

     A few months later after they have settled in some blighted and unwanted apartment dwellings or moved to their in-laws, the homeowner or now the new ex-homeowner receives in the mail a 1099-C (Cancellation of Debt) from the Mortgage Company. So what will she or he do now?

     The ex-homeowner should consult with an Enrolled Agent or a licensed Tax Professional such as a CPA or Tax Attorney, and pretty much the consultation will have a semblance of the following explanation:

(1)   A foreclosure is treated as a sale that may result in a gain or loss. If the outstanding loan balance is greater than the fair market value of the home and the lender cancels all or part remaining loan balance then one will realize ordinary income from the cancellation of debt. This amount should be reported as income on the tax returns, unless exceptions apply.

(2)   A qualified principal residence indebtedness exclusion is available if the mortgage taken out is to purchase, build or substantially improve a home. This loan must be secured by the main home of the borrower. Qualified principal residence indebtedness also includes any debt secured by the main home that is used to refinance a mortgage taken out to buy, build or substantially improve a main home, but only up to the amount of the old mortgage principal just before the refinancing.

(3)   This exclusion is provided by the Mortgage Forgiveness Debt Relief Act of 2007. This act generally allows taxpayers to exclude from income discharges of debt on their principal residence. Debt reduced through restructuring as well as mortgage debt forgiven in connection with this foreclosure qualifies for the relief. This debt relief applies to debt forgiven in years 2007-2012. Up to $2 million of forgiven debt is eligible for exclusion ($1 million for married filing separately). This exclusion does not apply if the discharge is for any other than a decline in the home’s value or the taxpayer’s financial condition.

     In conclusion, when a lender has written off or cancelled debt, as in a foreclosure, it will result in a 1099 C being issued to the borrower. The IRS views this as an income. But if handled correctly by an Enrolled Agent, who is licensed to practice before the IRS, or another licensed tax professional as a CPA or lawyer, he or she can totally eliminate any taxable consequence of these situations.

The Dichotomy of Competence and Integirty

     Originally published in the CA and NV Examiner 10/22/2010 issue 

    

      When Pres. Cory Aquino passed away, an overwhelming nostalgia engulfed a grieving nation. The people terribly missed the true democracy the late President propagated and the heroism and martyrdom that the late Senator Ninoy Aquino had demonstrated. The name of their son, Benigno Simeon C. Aquino III or P-Noy, as he wants to be called, at that time crossed the people's minds and became their symbol of hope, to a nation that is plagued with unparalleled corruption, in and out of the government.  Unfortunately, Noy was not even among the names of Presidentiables in this year’s 2010 elections. Because in reality, PNoy never sought the Presidency of the land.  But the Filipino people nonetheless, wanted him to be their President.

     And it came to pass...PNoy took the challenge and fifteen million Filipinos gave him the mandate, second only to Pres Gloria Arroyo’s 16 million. But contrary to Arroyo's being a recipient of perennial accusations of  massive electoral fraud, PNoy came out an undisputed winner, in a generally clean and honest presidential elections.  He holds the second biggest margin over his closest rival of 5 million in the presidential race second only to Joseph Estrada’s 6 million over Joe De Venecia in 1998. While PNoy stands as an antonym of Arroyo’s “dirty” election tactics, he became synonymous, at least during the election campaign, to former Pres. Estrada's questionable ability to discharge executive competence.  It was indeed during this campaign period that PNoy captivated his constituents with his aura of integrity but fell short in competence.

     That's done. That was the campaign period. Let's get to the real deal now that he is in office for more than 100 days. The following question now joins us at this point: “ Must we dichotomize integrity and competence in choosing a President?”  I honestly feel that  President Noy in exercising his leadership abilities must radiate both the qualities of sincerity and competence. You agree with my position, right? Question is, "did P-Noy demonstrate both qualities of Competence and Integrity in his first 100 days in office?" Let’s take a short review. First of all, let me give credit to my Fraternity brods, Christian Cardiente and Karl Barlaan in their article "Aquino’s First 100 days," which inspired me and gave me the material to write this article.

Case in Point: The Economy

     The Philippine economy grew by 7.9% in the first 100 days of PNoy mainly attributed to the stimulus that was created owing to the influx of money circulating in the economy at the aftermath of the elections and also to the export industry. Foreign investments is up by $1 billion in investments pushing up the peso against the dollar. Many economists attribute these positives to higher corporate earnings, increased exports, favorable expectations on the new government and renewed investor confidence. In this area, I would give my grade to PNoy as Passed in Competence.

    However, according to the World Bank, inspite of the economic growth of the Phil economy in this period almost half of the entire population remain poor and more than 38% of the population did not feel any difference or improvement in their living standards during this "robust" economy. These figures are confirmed by the SWS (Social Weather Stations).  A truly sincere leader should implement economic and social mechanisms in his government machinery so that the progress of the economy should trickle down to the poor, not only to the middle class or rich people in the society.  Maybe my comment here is in line with Economist and Professor Ben Diokno (who was my teacher in Microeconomics at UP Diliman), who said, “Where’s the road map?”  This map, Mr. Diokno might be looking for is one that will show us where the PNoy Administration should begin, in concert with all concerned, and how the benefits of our labor could  ultimately lead to the greater masses of the Filipino people.

     My personal grade  to the PNoy administration in this area is Failed in Integrity.

The August 23 Hostage Taking and the Jueteng Scandal

     This August 23 incident as well as the Jueteng scandal hurled numerous attacks against PNoy from his critics. The first, August 23 hostage taking, questioned his competence and the second, jueteng scandal, questioned his integrity. These two big issues penetrated and put  out in the open the fact that there is a tremendous partisan infighting going on inside the walls of the Malacanang Palace. During the August 23 crisis, PNoy distanced himself and did not want to interfere with Police matter. The two Palace Communications officials, Secretary Sonny Coloma and Secretary Ricky Carandang, according to press reports, gave conflicting advisories. They conflicted each other and only led to the unfolding of the fact that there are two warring factions among the Aquino supporters. Those that belong to the Samar group and the other the Balay.

     The DILG (Department of Interior and Local Government) is also another image and scenario of the same warring factions. Secretary Jessie Robredo is not in good terms with the shooting buddy of PNoy, DILG Undersecretary Rico Puno. One is said to belong to the Samar and the other to the Balay.  The President should really do something about this. If these people cannot work together for the good of the Administration, the President should start purging these warring government officials and bring in people who can work with each other in harmony.

     Many too question PNoy’s sincerity when the IIRC review took a long time at the Palace, because Malacanang  officials needed to make sure that they can have all the legal grounds covered to absolve Undersecretary Rico Puno of any administrative or criminal charges. As of press time, Puno had already been absolved of any administrative and criminal charges contrary to Justice Secretary Leila De Lima’s recommendation.

     But before Puno was absolved of these charges, Bishop Cruz accused the Aquino administration of condoning the flourishment of the illegal numbers game “jueteng” wherein his Undersecretary and best friend, Rico Puno, as one of the biggest jueteng protectors. This was confirmed by a privilege speech by Miriam Defensor Santiago who identified both Puno and former PNP Chief Verzosa as jueteng protectors. By the way, did you know that jueteng as reported by PNP Director Raul Bacalzo is  now a P37B industry?

     The grade I am giving PNoy Administration in this area is Failure in both Competence and in Integrity.

     I believe that PNoy who is well loved by the Filipino people as manifested by his overwhelming mandate will not have a problem in discarding the elements in his Administration who are pulling him down. PNoy can and will deliver the results expected of him to his true bosses-the Filipino people. While 100 days cannot really be a measure of his true competence and integrity, as well as the competence and integrity of his Administration, at least it gives us a sneak preview of the future. But one thing for sure Mr. President, please do not dichotomize competence and integrity.

Double Dip Phenomenon: Negative Growth

     Originally published in the CA and NV Examiner 10/15/2010 issue

     In my recent articles I have covered various current Administration’s policies that are anchored on the demand side, i.e.,  Keynesian oriented Obanomics. I have referred to various stimulus programs that are geared towards inspiring spending in the economy to subsequently give incentives to producers or manufacturers to increase their productivity. In turn, this should ultimately lead to positive economic growth. However, inspite of such programs, as in the Cash for Clunkers, and the like, the economy is achieving a very insignificant growth, at worse, maybe even negative growth. Some experts, especially on the side of the Administration, maintain that the U.S. economy is in a very slow but steady recovery. On the other hand, we cannot summarily dismiss the pessimists who are saying, which is not really surprising, that we are in for a negative growth or sometimes referred to as double dip.

     Why is there such an economic phenomenon as double dip or negative growth? Can we put it in proper perspective, against the backdrop of today’s economy, so that the layman and the readers of this column can understand why we are or could be in such a situation? I would like to give credit to Derek Thompson and Daniel Indiviglio, who helped me, through their research, put my points and ideas together.

      Okay, here goes my simplistic inference why we experience or will experience a negative growth, or double dip, in the economy. The explanation I am giving here is not really a cause and effect but merely an attempt to trace the roots of this phenomenon vis-à-vis today’s economy.

      Let’s start with the biggest concern of this Administration: The Housing Market.

     We all know that the housing market is plagued with weak sales.  The end result is a mounting real estate inventory. There’s just too much supply with a very weak demand. The immediate effect is for builders to shy away with construction of new homes since there’s a tremendous competition with home resale. New home prices are depressed thereby reducing construction jobs. Unemployment, lay-offs ensue and the sister industries directly and indirectly linked to housing are hardest hit. This domino effect will lead to more and more economic crisis, the most outstanding of which will be a soaring unemployment rate.

     Consequently, the decrease in home prices will make it even more difficult for the homeowners to sell their homes to avoid foreclosures and pan the market with more and more defaulting homeowners. The average American realizes that a lower home value effectively depletes the value of his wealth so he is encouraged to save more and spend less. The stock market goes down, the credit market tightens, and private investors and homeowners cut down spending. The resultant economic phenomenon joins us at this point. Growth in the economy turns negative.

     The residential market’s problems are indeed worsening. It will continue to become worse before it gets better. The foreclosures will continue as millions of homeowners have started defaulting or have already defaulted on their mortgages.  Even if we reach the point when foreclosures will start to decline, waves of defaults will follow as participants in the loan modification programs re-default, now at alarming rate of about 50%. Home and commercial real estate values will continue to decline as well as the assets that back them up. The banks who have big exposures to these toxic assets are in for another bout of losses. The investors who put in their money in these endeavors will start to question the stability of these banks. The stock market takes a dive and again the credit market is frozen. At this point again, the above economic phenomenon joins us. We experience negative growth in the economy.

Stimulus and Tax Cuts: Who are we Kidding?

Originally published in the NV and CA Examiner 10/08/2010 issue

     The common politician always argues that "we need to increase spending in the economy," as opposed to spending cuts, since "this is what is needed to speed up economic recovery."  From all angles, the current Administration's policies are built along this framework. On the contrary, history reveals that in fact it is the "cuts in spending to reduce deficits" which became the key to promote economic recovery. Where does the myth end and the reality begin?

     Today, we bear witness to the U.S. economy being bombarded with government spending through various stimulus packages with the expectation that the multiplier effect the Administration's economists are anticipating for will trickle down to increase in gross domestic product (GDP).  Sorry, Senor y Senoritas, the answer we have for now is "Nada." The effect on GDP is just too small we call them "de minimis" in the tax world.

     The flip side of this story is that stimulus spending is actually scary. It means that tax increases are coming! And more often than not, tax increases is a threat to economic growth! …..." Oh yeah! Where’s your evidence?” you may ask…..

     Well here’s the evidence….

     In a recent study conducted by Alberto Alesina and Sylvia Ardagna, Professors of Political Economy at the Harvard, they concluded that:

            (1) Large adjustments in fiscal policy if based on well-targeted spending cuts have often led to expansions, not recessions.

            (2) Fiscal adjustments based on higher taxes, on the other hand, have generally been recessionary.

     The study covered 107 large fiscal adjustments that took place in 21 countries between 1970 to 2007. According to their economic model, the results were striking. Over nearly 40 years, expansionary adjustments were based mostly on spending cuts, while recessionary adjustments were based mostly on tax increases.

     Let’s look at the scenario why spending cuts can be expansionary:

First and foremost, such a policy will signal that no tax increases will occur in the near future, or even if did, it will be relatively smaller. Government should present a transparent and credible plan that will surely cut outlays. This will therefore create an impression in the minds of the people that no changes on future tax liabilities are coming. Subsequently, this will be transferred and manifested in the behavior of consumers and more importantly investors who will be willing to spend and invest, since both camps foresee no tax increases, at least over a sustainable period.

      On the contrary, fiscal adjustments based on tax increases will reduce the disposable income of consumers and subsequently reduce incentives for productivity.

     In today’s U.S. economy, there are still a lot of firms that are profitable. The problem is, they do have large unspent idle resources due mainly to uncertainty over the regulations on taxes, which directly discourage them from taking risks in investments as well as consumption.

     In conclusion, we are able to discern that the United States is at a greater risk from the increased Obama’s stimulus spending rather than undertaking gradual and credible spending cuts. The evidence from the last 40 years does not lie. Spending increases that is meant to stimulate the economy and tax increases to reduce deficits just don’t work.  The writing is on the wall! Who are we kidding?