If the IRS finds the banks guilty, investors may ultimately be the ones that will be paying for the damages.
The Internal Revenue Service said a review will be conducted on the tax exemption of Real Estate Mortgage Conduits (REMICs), a prevalent mortgage-backed securities type. The move is to check if banks indeed violated tax requirements when transferring mortgages to REMICs. The financial blow could be huge if the IRS finds evidence of violation. Behind REMIC investments are pension funds like individual retirement plans such as 401(k)’s and by state and local government bodies.
The Securities Industry and Financial Markets Association said the sum of REMICs investments for 2010 was $3 trillion. The IRS is aware of questions in the market regarding REMICs and proper ownership of the underlying mortgages as set out in federal tax law, and is actively reviewing certain aspects of this issue, added the agency. The agency gave no word if there are any plans of taking action.
But because of the review, investors’ interest in mortgage-backed securities may be threatened by the pervasive misdemeanors in home foreclosures. Mortgages came from banks which turned them into securities. Banks failed to turn-over mortgage ownership to the trusts that invested in them. These were followed with fraudulent mortgage assignment design and further false documents which were all confirmed by the courts and the federal bank regulators. On the collapse of the housing market, losses were suffered by these investment trusts. Further harm was done to them when courts barred defaulted mortgage foreclosures for lack of documents required to establish mortgage ownership.
Investors are attracted by REMICs’ non-‘double-taxed’ while individual investors pay taxes on REMICs-derived income. Securities are business tax-exempt. In the event that the IRS decides there were REMICs federal tax code failures, the investments will pay 100% tax from the income earned. The IRS may end up collecting the full amount plus there may be further penalties due to non-filing of income tax returns.
Securitized investments taxation expert James Peaslee said the IRS may not be able to immediately act given that the penalties could be financially damaging in case the offense is proven. Investors, the ‘innocent parties’, will end up paying instead of the banks, added Peaslee. But if the IRS doesn’t act, it would be a backdoor bailout of the financial system, said Adam Levitin, professor and taxation expert.
If penalties are enforced by the IRS, the banks may face lawsuits from REMICs and the banks may ultimately shoulder the costs. If the IRS is able to prove an offense but fails to act, potentially enormous tax revenue that would be passed on to the federal government will be sacrificed, said Levitin. With the current federal budget deficit, that’s not something to sniff at, he added. To some REMICs, bank charges may be limited as legal aid lawyer April Charney said that REMICs investors have a limited time to sue banks with faulty transfer of promise mortgages.
The IRS will have to establish if mortgages from where incomes are derived are actually REMICs-owned. Otherwise, they can’t be categorized as REMICs hence the incomes are supposed to be taxable. The arcane tax rules prevailing REMICs tax rules dictate that mortgages have to be turned over to them on the day they are made. They are given 120 days to fix any inaccuracies then they can no longer acquire further mortgages. REMICs are passive, static investment vehicles which exempt them from taxes, thus, the limitation, said Levitin. Continued mortgage buying and selling would mean they are regular businesses requiring regular income tax payments. According to Peaslee, the U.S. Tax Court has not yet set any policies for REMICs timely mortgage ownership requirements.
