NCUA and IRS Hot Topics
Credit Union Advisor, 2008 Winter


The NCUA has again indicated areas in which it is particularly concerned as we head into 2008 examinations. Making sure your house is in order in these particular areas could help examinations go more smoothly and efficiently.

First, the NCUA continues to see problems in the area of due diligence programs. With ever increasing complexity in credit unions, the need for formalized due diligence programs has never been greater. Four components common in quality due diligence programs include proper planning (including setting interim goals), monitoring (making sure the new program stays within boundaries established during program), controlling (control your growth rate - good programs fail because growth is faster or higher than expected and the credit union isn’t in the position to handle it), and having an exit strategy. While you don’t want to plan to fail, it is important to plan an exit strategy in advance.

Second, it goes without saying that the NCUA will continue to monitor credit risk. Significant re-pricing of loan portfolios will continue into 2008. Will members be able to make the increased loan payments? According to First American Real Estate Solutions, of the $4 trillion of total mortgage originations in 2004 and 2005, over 47 percent of these mortgages had adjustable rates.

Third, ongoing risk monitoring programs will be expected from credit unions. Monitoring risk in all areas of your credit union will be required, but especially in the areas of information technology, BSA, and liquidity. Other areas you can expect the examiners to focus on include collection programs, disaster recovery, and strategic planning.

Interagency Guidance on Allowance for Loan Losses 

In light of the current economic situation and potential credit quality issues within loan portfolios, we thought it might be appropriate to remind you about the recent guidance from regulators (Interagency Policy Statement on ALLL) concerning proper methodology in establishing your allowance for loan and lease losses. In addition to paying close attention to your loan pools and the ratios applied to them, it is also important to consider qualitative or environmental factors that are likely to cause losses which might differ from historical loss experiences. The policy statement also calls for board of director involvement in the ALLL process. Most prevalent in the policy is the requirement to keep the underlying support for how the allowance was determined. All adjustments to the historical factors should be documented.

Home Mortgage Debt Forgiveness Relief 

For indebtedness discharged on or after January 1, 2007 and before January 1, 2010, the Mortgage Forgiveness Debt Relief Act of 2007 (MRA) generally allows taxpayers to exclude up to $2 million of mortgage debt forgiveness on their principal residence. Specifically, the MRA provides that gross income does not include any discharge of qualified principal residence indebtedness. The basis of the taxpayer’s principal residence is reduced by the excluded amount, but not below zero.

Qualified principal residence indebtedness is acquisition indebtedness under Code Sec. 163(h)(3)(B) with respect to the taxpayer’s principal residence, but with a $2 million limit ($1 million for married individuals filing separately). Acquisition indebtedness of a principal residence is indebtedness incurred in the acquisition, construction, or substantial improvement of an individual’s principal residence that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing does not exceed the amount of the refinanced indebtedness.

This exclusion does not apply to the discharge of a loan if the discharge is due to services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the taxpayer’s financial condition. This exclusion also does not apply to a taxpayer in a Title 11 bankruptcy. An insolvent taxpayer (other than one in a Title 11 bankruptcy) can elect to have the mortgage forgiveness exclusion not apply and can instead rely on the Code Sec. 108(a)(1)(B) exclusion for insolvent taxpayers. As mentioned above, this exclusion applies only to a taxpayer’s principal residence. Therefore, while interest for a taxpayer’s vacation home may be deductible, debt forgiven with respect to such vacation home is not excludible from the taxpayer’s gross income.

Mortgage Insurance Premiums as Interest 

The MRA also extends the rules for treating qualified mortgage insurance premiums as deductible qualified residence interest for three years. This extension applies to amounts that: (1) are paid or accrued before January 1, 2011; (2) are not properly allocable to any period after December 31, 2010; and (3) are paid or accrued with respect to a mortgage insurance contract issued after December 31, 2006.

These rules relate to premiums paid or accrued by a taxpayer during the tax year for qualified mortgage insurance, in connection with acquisition indebtedness, with respect to a qualified residence of the taxpayer. Such premiums may be treated as qualified residence interest, subject to a phase-out based on the taxpayer’s adjusted gross income (AGI) as discussed below.

Qualified mortgage insurance means mortgage insurance provided by the Veterans Administration (VA), the Federal Housing Administration (FHA), or the Rural Housing Administration (RHA), and private mortgage insurance, as defined by Sec. 2 of the Homeowners Protection Act of ‘98 as in effect on December 20, 2006.

The amount of mortgage insurance premiums treated as qualified residence interest may be reduced if taxpayers AGI exceeds certain levels.

For 2007 tax information reporting purposes, Form 1098 – Mortgage Interest Statement – now includes a new box, number “4”, entitled “Mortgage Insurance Premiums.” This box should be utilized to report qualifying mortgage insurance premiums. Only amounts of $600 or more need to be reported.