Despite President Obama's hint to the contrary, Social Security checks can still be paid on August 3rd, even if an agreement on increasing the debt ceiling is not made.

We shouldn’t worry about not getting Social Security checks after August 3^rd.  According to Jagadeesh Gokhale, in an article that can be found here, despite the President’s dire hints that Social Security checks would be interrupted on August 2, there is every reason to believe that Social Security payments will be made in full in August, and for many more months, no matter whether the budget deadlock is resolved by August 2^nd.  This is because among other reasons, even if the debt limit is reached, Social Security payments that are covered by incoming payroll taxes would not be delayed. 

Gokhale describes it thus:

The debt limit encompasses both debt held by the public, and that held in intra-governmental accounts such as Treasury IOU's in the Social Security Trust Funds. Even if the debt limit is reached, Social Security payments covered by incoming payroll taxes would not be delayed. As some observers correctly point out, payroll taxes are insufficient to cover present-law Social Security benefits. But that's true only on an annual basis. Because the payroll tax rate is applied to earnings, those tax withholdings generate more revenues during earlier months of the year than during later ones -- when higher earners' taxable earnings limit is reached and payroll tax collections decline. That means the still quite small annual payroll tax shortfall will not emerge until November or December of this year. Therefore, no Social Security beneficiaries should miss their payments in August.

Even if payroll taxes were to fall short of scheduled benefits on August 3rd, there is a way to ensure that Social Security checks are mailed on time. The Social Security Trust Funds would simply exchange their Treasury IOUs for cash from Treasury, financed out of non-Social Security taxes. This is exactly how they are to be used in the event of a payroll tax shortfall anyway. But this redemption of Trust Fund IOUs would reduce federal debt below the current debt limit. Treasury could then simply issue more public debt to recover the cash -- in effect exchanging debt to the Social Security Trust Funds for debt held by investors.

So, despite the heated rhetoric surrounding whether or not to raise the debt ceiling, Social Security checks can still be paid on August 3^rd.

Update on Thursday, July 21, 2011 at 9:16AM by Jess Monnette

Following up on the Gokhale article is a new article which fleshes out the ability of Social Security to make all necessary benefit payments.   

The authors are Nancy Altman (co-director of Social Security Works and co-chair of the Strengthen Social Security coalition and campaign) and Mark S. Scarberry (Professor at Pepperdine School of Law).  

Update on Thursday, July 28, 2011 at 11:20AM by Jess Monnette

Altman and Scarberry have updated the original op-ed in light of President Obama's Monday night speech.  You can find more info at the TaxProf Blog here. 

35 year old temporary surtax ends today!

Today marks the end of a "temporary" 0.2% Federal Unemployment Tax Act (FUTA) surtax.  This surtax was originally created as a "temporary" surtax to replenish Federal coffers for unemployment benefit payments made during the 1973-1975 recession.  Although the repayment was completed in 1987, Congress has seen fit to extend the surtax eight times to the present.  Since 1987, the surtax has raised an additional $46 billion (adjusted for inflation) above and beyond the needed revenue in 1976.  

As Way and Means Comittee Chairman Dave Camp said, "The fact that it has taken 35-years for this ‘temporary’ tax to expire clearly illustrates the dangers of higher taxes – once in place, they are unlikely to ever go away." 

You can learn more about it here. 

Short Sales: Basis Implications

A discharge of indebtedness under § 108(a)(1)(E) (for more info check here) will reduce the seller’s tax basis in his house (but not below zero),  and therefore may result in the seller having a greater capital gain on the sale of his property.  See IRC § 108(h)(1).  This capital gain may, however, be excluded under the § 121 rules that exclude gain from the sale of a principal residence.  No loss deduction is allowed on a short sale of a personal residence because personal property losses are only allowed for losses arising from fire, storm, casualty or theft.  The exclusion (§ 108(a)(1)(E)) is claimed by filling out a Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) which is attached to the taxpayer’s tax return.  Any person that is considering a short sale should seek competent professional advice to determine whether or not the § 108(a)(1)(E) exclusion applies and what other basis implications and capital gain implications exist. 

Short Sales: General Tax considerations.

Generally, if a bank forgives a debt (e.g. the short seller’s deficiency amount), the debt forgiveness constitutes “cancellation of debt” (COD) income under IRC § 61(a)(12).  Under that section COD income is taxable income which will be reported on the taxpayer’s 1040 form.  This general rule, however, may not apply in short sale situations.  Per IRC § 108(a)(1)(E), a taxpayer does not have to include COD income when the discharged indebtedness constitutes “qualified principal residence” indebtedness discharged from January 1, 2007 and January 1, 2013. 

Qualified principal residence indebtedness means acquisition indebtedness as defined under IRC § 163(h)(3)(B).  Generally, this means debt that was incurred in acquiring, constructing, or substantially improving the taxpayer’s principal residence and is secured by the residence.  See generally § 108(h) and § 163(h)(3)(B).  Note that this definition does not include all types of debt on a home, specifically refinance debt and second mortgage situations, and the taxpayer needs to verify that their situation falls within all of the statutory definitions of “qualified principal residence” and “acquisition indebtedness.”  A seller that is considering selling his house short should verify the tax implications of the short sale with a competent advisor prior to entering into any agreement to sell the house.    

Short Sales: What is a deficiency in a short sale?

A deficiency in a short sale is the difference between the net sale proceeds of the house and the outstanding loan balance owed on the house.  As an example:

Net home sale proceeds	$200,000.00
1st deed of trust balance owed at time of sale	($240,000.00)
Seller’s deficiency	($40,000.00)

In a short sale, when the seller’s bank chooses to release its deed of trust, it may either (1) demand that the seller personally cover the deficiency (and the seller will still be responsible to pay back the deficiency), or (2) may agree with the seller that the bank will not pursue the seller for a balance owed on the deficiency.  Therefore, in the example, if the seller does not want to be on the hook for the $40,000.00 deficiency then he must obtain the bank’s written agreement that he will be released from owing the deficiency.  The seller should seek professional advice to verify that the agreement is binding on the bank and make sure that his interests are protected.