MBA Asks Treasury, IRS for Guidance on Qualified Business Income Deduction

Mike Sorohan msorohan@mba.org

June 06, 2018

The Mortgage Bankers Association this week submitted a letter to the Treasury Department and the Internal Revenue Service, asking for confirmation that mortgage banking companies are eligible for the deduction of qualified business income under new Section 199A of the Internal Revenue Code.

In the letter, MBA asked Treasury and the IRS to issue guidance clarifying its interpretation of Section 199A, passed under the recent Tax Cut and Jobs Act, which allows a 20 percent deduction of qualified business income from entities organized as pass-through entities (e.g., a partnership, S corporation or sole proprietorship). MBA said it believes the purpose of Section 199A was to maintain a competitive balance between C corporations (which benefit from a greatly reduced tax rate under the Tax Cuts and Jobs Act) and pass-through entities that compete with C corporations; this would, MBA said, include mortgage banking companies.

"We believe that the law, congressional intent and sound tax policy strongly support that conclusion," MBA said. "Mortgage banking companies are in the business of financing real estate, with a focus on financing real estate for borrowers in markets across the country--by connecting the real estate financing needs of local communities to global capital markets. As a type of mortgage banking company, independent mortgage banking companies tend to have a more regional business focus and are not affiliated with depository banking institutions."

MBA added many independent mortgage banking companies are organized as pass-through entities and compete directly with mortgage banking companies with a national footprint, "as well as banks and other lending institutions engaged in financing to provide real estate capital for multifamily rental housing, single-family homes, retail centers, office buildings, industrial facilities and other real estate in our economy."

The letter noted in crafting Section 199A, Congress intended the deduction to apply to actual business income of pass-through entities (i.e., income generated as a result of business activity)--not to wage income or its equivalent. To prevent the pass-through deduction from applying to wage income re-characterized as business income, Section 199A carved out certain exclusions. One such exclusion applies to pass-through entities that are a "specified service trade or business."

MBA said under the Act's definition, mortgage banking companies are not excluded from the Section 199A deduction. It pointed out Section 199A excludes from the 20 percent deduction entities engaged in a "specified trade or business," which it defines by reference to Section 1202(e)(3)(A). MBA said mortgage banking companies do not, however, fall within the trades or businesses listed in Section 1202(e)(3)(A). For example, the typical mortgage banking company receives income from engaging in a variety of real estate financing activities, including:

--Delivering capital by originating, underwriting, processing mortgage loans and other financing activities;

--Delivering these loans to investors, government-sponsored enterprises, lenders or securitization vehicles;

--Performing a wide variety of mortgage servicing activities, including collection, foreclosure and collateral preservation, and collecting payments; and

--Securing mortgage insurance coverage or guarantees from FHA, VA, Rural Housing Service and/or private mortgage insurers.

"These activities are part of the business of financing--which is not a specified trade or business identified in Section 1202(e)(3)(A)," MBA said. "The income from these activities is also not akin to wages for services - in contrast to the nature of income in the fields of business listed in Section 1202(e)(3)(A). As a result, in addition to not being specifically listed in Section 1202(e)(3)(A), mortgage banking companies do not create heightened re-characterization risk."

Moreover, MBA asserted mortgage banking companies cannot be considered a specified trade or business under the Section 1202(e)(3)(A) definition that includes "any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners." Rather, MBA said, in performing these activities, the principal assets of mortgage banking companies include systems, processes and technology that support the origination, processing, sale and servicing business functions, as well as legal, contractual relationships with investors, issuers, lenders, insurers and/or federal housing agencies.

"Such business contracts are backed by written policies and procedures for the companies, which are audited by outside auditors and other parties," MBA said. "The policies and procedures, along with the other assets of the company, support the mortgage banking company as an operating entity, not individual employees or owners. Mortgage banking companies also hold necessary entity-level licenses, registration and other business authorizations with state and/or federal government agencies in order to engage in the business of financing real estate."

Additionally, MBA said mortgage banking companies are not excluded from the Section 199A deduction under Section 199A(d)(2)(B), which excludes any trade or business engaged in the "performance of services that consist of investing and investment management, trading, or dealing in securities."

"The use of the term ‘performance of services' is intended to limit the application of Section 199A(d)(2)(B) to activities that are performed on behalf of third parties such as customers or borrowers," MBA said. "In effect, for a business to be excluded under Section 199A(d)(2)(B), it must engage in activities that both involve the ‘performance of services' on behalf of third parties, and ‘consist of investing and investment management, trading, or dealing in securities'...mortgage banking companies perform a wide range of activities as part of the business of financing real estate, including working with borrowers to originate loans. Some mortgage banking companies may sell loans they originate into the secondary capital markets."

Because of these interpretations, MBA said Treasury and the IRS must issue guidance confirming that mortgage banking companies, including independent mortgage banking companies, are eligible for the Section 199A pass-through deduction. "That conclusion is consistent with the law, congressional intent, and sound tax policy that supports maintaining a competitive balance and a level playing field among C corporations and businesses organized as pass-through entities," MBA said.

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