2007 Tax Law Changes

Mortgage Forgiveness Debt Relief Act of 2007

President Bush signed the Mortgage Forgiveness Debt Relief Act Dec. 20, 2007. Here's a summary of the bill's main provisions.

Income from Discharge of Indebtedness on Principal Residence

This provision is effective Jan. 1, 2007, through Dec. 31, 2009. Under this provision, which adds new IRC section 108(a)(1)(E), the discharge of qualified principal residence indebtedness is excluded from gross income. For purposes of the exclusion, qualified principal residence indebtedness is acquisition indebtedness (to buy, build or improve the residence) up to $2 million ($1 million for Married Filing Separately). The home must be owned and used as a principal residence (within the meaning of section 121). The basis of the home must be reduced (but not below zero) by any debt forgiveness excluded under this provision.

If only a portion of the loan discharged is qualified indebtedness, the exclusion applies only to the amount of debt discharged that exceeds the amount of the loan that exceeds the nonqualified indebtedness.

For example, assume that a taxpayer has a $500,000 loan outstanding on his principal residence, of which $80,000 is equity debt. If $100,000 of the loan amount is discharged, only $20,000 ($100,000 discharged debt — $80,000 equity debt) of the debt discharge qualifies for the exclusion under the new provision.

This provision does not apply to discharge of indebtedness on account of services performed for the lender. Also, an insolvent taxpayer must use the principal residence exclusion instead of the insolvency exception, unless the taxpayer makes an election to apply the insolvency exception instead of the exclusion provision.

Exclusion of Sale of Residence Gain for Surviving Spouses

This provision is effective for sales and exchanges after Dec. 31, 2007. For sales within 2 years of a spouse's death, the capital gain exclusion is increased to $500,000 if the surviving spouse hasn't remarried and the ownership and use tests were met by both taxpayers immediately before the date of death. This provision adds new section 121(b)(4).

Volunteer Firefighters and EMTs

This provision, effective Jan. 1, 2008, through Dec. 31, 2010, adds new section 139B and allows volunteer firefighters and emergency medical responders to exclude from income a qualified state and local tax benefit (reduction or rebate of a tax) or qualified payment made on account of performance of qualified services. The maximum exclusion is limited to $30 multiplied by the number of months during the year that the taxpayer has performed the volunteer services. The maximum exclusion is $360.

Eligible volunteers must provide services to a "qualified volunteer emergency response organization" which means any volunteer organization that is:

• organized and operated to provide firefighting or emergency medical services for persons in the state or political subdivision
• required (by written agreement) by the state or political subdivision to furnish firefighting or emergency medical services in such state or political subdivision

Failure to File a Partnership Return

Effective for returns required to be filed after date of enactment, this provision increases the time to assess the failure to file penalty from 5 months to 12 months. It also increases the penalty amount from $50 per month to $85 per month.

Failure to File an S Corporation Return

This provision is effective for returns required to be filed after date of enactment. It adds new section 6699 and implements a failure to file penalty for S corporation returns. An S corporation will be subject to the penalty if:

• it's required to file a tax return but fails to do so timely
• it files a return but fails to show the required information

The penalty is imposed for each month (or fraction of a month) during which the failure continues, not to exceed 12 months. The penalty for any month is determined by multiplying $85 by the number of shareholders during any part of the year.