October 1, 2018
Hon. Steven Mnuchin Hon. Charles Rettig
Secretary, Department of the Treasury Commissioner, Internal Revenue Service
1500 Pennsylvania Avenue NW 1111 Constitution Avenue NW
Washington, DC 20220 Washington, DC 20224
Internal Revenue Service Proposed Amendments to the Income Tax Regulations (26 CFR part 1) under Section 199A – Qualified Income Business Deduction [REG-107892-18]
Dear Secretary Mnuchin and Commissioner Rettig:
We write as independent mortgage bankers (IMBs) to submit comments and recommendations in response to this Notice of Proposed Rulemaking to establish regulations to implement the 20 percent deduction for Qualified Business Income for individuals, partnerships, S corporations, trusts, and estates under Section 199A of the Internal Revenue Code, as established by the Tax Cuts and Jobs Act of 2017 (Pub. Law 115-97, Dec. 22, 2017).
We write to make two principal recommendations:
(1) Include language in the final rule stating that mortgage banking firms are not a Specialized Service Trade or Business (SSTB) and are eligible for the passthrough deduction, and
(2) Include language in the final rule stating that the sale of mortgage loans that are originated by a firm, including a sale executed through a securitization, is not a securities activity for the purposes of passthrough eligibility and therefore is not a financial service.
Mortgage Banking Firms Should Be Explicitly Cited as Eligible for Passthrough Deduction
The statutory provisions and proposed rule clearly appear to make nonbank mortgage banking firms (IMBs) eligible for the 20% deduction for passthrough small business entities – and their core activities of making mortgage loans through loan originations and mortgage servicing clearly appear to be eligible activities. This interpretation is supported by several points:
- Mortgage banking firms do not fall into the SSTB category of “financial services,” because their core activity is making a loan (through mortgage origination) and the proposed rule makes it clear that “making a loan” is not a Financial Service.
- Mortgage banking firms do not fall into any of the other enumerated categories in Section 1202(e)(3)(A) that explicitly identify SSTBs – including “health, law, accounting, actuarial science, performing areas, consulting, athletics, financial services, brokerage services.”
- The principal assets of a mortgage banking firm are its tangible assets – its capital, its loan products, its technology and underwriting systems, its relationships with loan program operators (such as FHA, Fannie Mae, or Freddie Mac), and its state licenses to originate loans. The principal asset of a mortgage banking firm is not the “reputation or skill of its employees or owners” – an explicit test about whether an entity is an SSTB.
- Revenues of a mortgage banking firm are not a proxy for wages (a key consideration in Congress creating the SSTB classification and disallowing the deduction for certain firms), but instead are derived from performance-based mortgage origination and loan servicing.
- Mortgage banking firms facilitate the type of activity that Congress intended to incentivize: the manufacture of mortgage loans that stimulate home construction and consumer purchase of ancillary goods such as furniture, refrigerators and the creation of jobs, with labor intensive hiring of mortgage loan originators, underwriters, and servicing staff.
Therefore, the final rule should explicitly state that mortgage banking firms are eligible for passthrough treatment.
Loan Sales of Mortgage Loans Should Not be Considered a Securities Activity
Since mortgage banking firms routinely engage in mortgage loan sales, we are concerned that this could raise issues about whether this activity could result in such activities being classified as a securities activity, which would fall into the category of a disqualifying Financial Service.
We believe that any such classification – at best resting on tax law treatment that is unrelated to the purposes of the passthrough provision – would be inconsistent with the statutory language and Congressional intent of the legislation creating this provision.
Moreover, as mortgage banking firms, we believe that a final rule that would treat us as engaging in securities activities in the context of determining whether we are eligible for passthrough treatment would be an absurd outcome for many reasons:
- The proposed rule states that the purpose of Section 199A is “to provide a deduction based on the character of the taxpayer’s trade or business.” The primary activity of a mortgage banking firm is to originate a mortgage loan, the essence of which is the manufacture of a new loan secured by a mortgage with detailed underwriting requirements (and in many cases supported by the related labor-intensive activity of servicing that loan). Disallowing passthrough treatment on the grounds that a subsequent sale of such loan is inherently a securities activity is inconsistent with this character of the trade or business test.
- Applying Section 475 securities definitions (which consider a mortgage banking firm to be engaging in securities activities if it either regularly purchases or sells securities) does not make sense in the context of this new passthrough tax provision – which is not about the tax treatment of the transaction but about the underlying characteristics of the activity.
- None of us are registered as securities dealers.
- The mere activity of selling mortgage loans is not considered a securities activity under securities law (in the same way that making loans is not considered a securities activity).
- With regard to the customary types of sales of mortgage loans, none of us earn any revenues from the “performance of services” for third parties – a consideration as to whether an entity is engaging in securities activities in the context of the passthrough deduction.
- With respect to the sale of mortgage loans to an aggregator or a cash window sale to Fannie Mae or Freddie Mac, no securities are even involved – the actual sale is merely a whole loan sale of individual loans.
- Even when a mortgage loan sale is executed through a securitization (e.g., a Fannie Mae or Freddie Mac MBS or a GNMA security), we retain the services of a third-party securities broker-dealer to execute the transaction – and these securities firms carry out the securities activities of selling securities to their clients and complying with securities requirements.
- Relevant language regarding securities activities refers to “selling securities to customers.” However, a mortgage banking firm’s “customers” are its borrowers – not the entities that buy mortgage loans or mortgage securities.
Regarding this last bullet, it is important to reiterate that the core activity of a mortgage banking firm is the manufacture of a new mortgage loan. This requires extensive activities including underwriting the loan, securing a mortgage lien, and executing a loan closing. Therefore, it is hard to understand how a mortgage banking firm’s eligibility for the passthrough deduction – which is based on the core activity of mortgage loan origination – could be subsequently disallowed based on the discretionary decision to sell that loan, whether done in order to maximize the value of that loan or to re-liquify the firm in order to be able to originate even more mortgage loans.
Finally, treating the sale of mortgage loans as a securities activity would result in a potentially complicated or unworkable regime in which a mortgage banking firm that changes its mix of sales and loan retentions from year to year could go back and forth between being an SSTB one year and not being an SSTB the next year – even though its core underlying activities do not change.
Changes to the Rule to Clarify that Sales of Mortgage Loans are Not Securities Activities
When interpreting and implementing a Congressional statute creating a new provision, it is appropriate to use existing definitions and standards in the proper context of the language and intent of the new statute and provision.
As noted, under Section 475, a taxpayer that “regularly purchases securities from or sells securities to customers in the ordinary course of business” could be considered a “dealer in securities.” Moreover, under existing tax regulations, making a loan could be considered to be purchasing a security. If these definitions and tax treatments were to be used in considering eligibility for passthrough treatment, the making of a loan could be considered to be a securities activity – and therefore a financial service – making the activity ineligible for passthrough treatment.
Instead, the proposed rule appropriately considers the making of a loan in the proper context of the new passthrough deduction – and states that it is not a financial service and therefore inferentially that it is not a securities activity.
It is appropriate to do the same with regard to the other prong of this test – the sale of securities – in the context of the mere sale of (mortgage) loans.
For all the reasons identified in the previous section, and consistent with Congressional intent, the appropriate treatment is to clarify in the final rule that the sale of a loan that is made by that same firm is neither a Financial Service nor is it a securities activity.
Thank you for your consideration of these comments and requests.
Platinum Home Mortgage, Rolling Meadows, IL
LLG Loans, Troy, MI
Mountain West Financial, Redlands CA
MLB Residential, Springfield, NJ
AmeriFirst Home Mortgage, Kalamazoo, MI
Hallmark Home Mortgage, Fort Wayne, IN
Golden Empire Mortgage, Bakersfield, CA
Stockton Mortgage Company, Frankfort, KY
Absolute Home Mortgage Corp. Fairfield, NJ
Cherry Creek Mortgage Company, Greenwood Village, CO
SimpliFi Mortgage, LLC, Las Vegas, NV