Two more comments have arrived in response to Why This New Tax Provision. The first is from Wayne Brasch. The second will be shared in next Monday's posting. Wayne shares my distaste for the complexity generated by converting a small portion of what would be an itemized deduction into an above-the-line deduction. More on that issue will appear in next Monday's posting.

Wayne directed my attention to another provision in the Housing and Economic Recovery Act of 2008, P.L. 110-289. In section 3011 of this legislation, Congress provides a tax credit for individuals who are first-time homebuyers of a principal residence in the United States between April 9, 2008, and June 30, 2009. The credit equals 10 percent of the purcahse price, but is limited to $7,500 ($3,750 for taxpayers who are married filing separate returns), allocated among joint purchasers who are not married. The credit is reduced if the taxpayer's modified adjusted gross income exceeds $75,000 ($150,000 on a joint return), at a rate that eliminates it for taxpayers with modified adjusted gross incomes of $95,000 or more ($170,000 or more on a joint return). In the interest of brevity, I omit the definition of modified adjusted gross income, first-time homebuyer, principal residence, purchase, purchase price, and the treatment of constructed residences and purchases from related taxpayers. I also omit discussion of the exceptions.

What irks Wayne is the recapture provision. Section 36(f) provides, with several exceptions, that during the 15-year recapture period the taxpayer who claims the credit must increase tax liability by 1/15 of the credit. In other words, the credit isn't a once-and-done deal but the equivalent of a loan. For example, a taxpayer who claims the full $7,500 credit in the year of purchase must add $500 to his or her tax liability for each of 15 years, beginning with the second taxable year following the year in which the purchase was made. If the taxpayer sells the residence, the remaining unrecaptured credit must be added to tax liability. The only limitation on this accelerated recapture is that it cannot exceed the taxpayer's gain on the sale of the residence. Exceptions exist for death, involuntary conversion, and transfers between spouses or incident to divorce.

Here is what Wayne noted with respect to this credit: "These people are going to have to be concerned with paying for their house and keeping up with when it's time to begin to repay the "interest-free governmental loan". What will IRS to do recover this money from those who don't or can't repay it timely? Will they actually take back the house the government helped them purchase? This is really going to complicate the lifes of IRS and tax preparers in general." Indeed. If the taxpayer is unable or unwilling to pay the recapture tax, does the IRS jump in ahead of the first mortgagee, or is the IRS relegated to a secondary position? Does the IRS have a lien on the property from the time the credit is claimed, or only after it files in response to nonpayment of taxes in a subsequent year? Does the Congress really want the IRS to be in the business of foreclosing on homes, or forcing their sale, in order to collect taxes that would not have existed but for the credit? If the taxpayer would not have purchased the house but for the credit, isn't the Congress putting the United States Treasury into the same position as many sub-prime lenders put themselves when they made it possible for someone to acquire a home who wasn't financially ready to do so? If the banks making the bad loans are bailed out by the United States, who bails out the United States?

Another thought crossed my mind. To the extent the government decides to assist people in purchasing homes, is that not within the bailiwick of the FHA, to be administered through loans made or guaranteed by FNMA and FHMC? Why now get the Treasury Department into this business? Unlike the credit for first-time home purchases in the District of Columbia, a provision designed to entice people to purchase homes in Capitol Hill's backyard that would otherwise continue to spiral into the consequences of local government mismangement, this new provision does not target economically depressed areas or neighborhoods with higher than average foreclosure rates.

The temporary nature of this credit also raises questions. It suggests that Congress expects the "problem" to be fading away by the middle of 2009. The problem, it seems, is that housing sales have dropped. Housing sales have dropped because the veil has been removed from the mortgage lending market, and those not financially ready to own homes cannot get loans. Is the solution to have the government lend them money in the form of a must-be-paid-back tax credit because the private sector has finally come to its senses and put an end to irresponsible lending practices?

Yet another concern pops up. This credit is refundable, and there is a reason for that. Many taxpayers with adjusted gross incomes making them eligible for the credit will have tax liabilities that are less than the credit. A useless credit isn't much of an incentive whether or not one agrees with the incentive. This nation has had an educational experience with refundable credits targeted toward low-income taxpayers. The earned income tax credit has spawned so many schemes, many fraudulent, and has caused such havoc among taxpayers and tax return preparers, that the Congress should beware of imitating it without taking steps to minimize the temptations it presents to the schemers who would manipulate it to their advantage. Will the IRS end up directing even more of its resources toward audits of low-income home purchasers as it has had to direct a disproportionate amount of its resources toward auditing the earned income tax credit?

This seems to be another in the long line of tax provisions tossed into the Internal Revenue Code during the past decade that reflect the "Wouldn't it be cool if…?" approach to decision making that permeates post-modern America. Where are the studies that carefully consider the full implications of enacting this credit? When were the hearings that put the spotlight on this provision? Does anyone know if this credit will have any meaningful impact on the economy or the housing sector? Is this simply a matter of tossing another provision into the Code and seeing if it works, figuring that if it does, fine, and if it doesn't, oh well, no one reduces the lobbyists' salaries or votes the incumbents out of office for the gaffe?

Wayne's closing comments are a fitting end to this peek at new section 36: "I just think this whole law was a very ill-conceived thing that got through Congress somehow. I've been in the tax preparation profession since 1963 and have never seen such a crazy concept as contained in this law. I realize the economy needs a kick in the pants, but this is not going to do it."

I'm certain everyone knows who I think needs a kick in the pants, and it isn't the economy and it isn't Wayne.
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