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CHLA letter to Sec. Mnuchin and Comm. Kautter re: Tax Pass-through – 9/4/18

September 4, 2018
Hon. Steven Mnuchin                                      Hon. David J. Kautter
Secretary, Department of the Treasury         Commissioner, Internal Revenue Service
1500 Pennsylvania Avenue NW                      1111 Constitution Avenue NW
Washington, DC 20220                                   Washington, DC  20224
RE:  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 Acting Commissioner Kautter:
The Community Home Lenders Association (CHLA) is pleased to submit these comments 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).
As the only national association exclusively representing non-bank mortgage bankers, CHLA appreciates the language in the proposed rule that explicitly excludes “the making of loans” from the definition of “Financial Services.”  This is important because the primary activity of mortgage banking is making mortgage loans, and whether an activity is defined as a Financial Service is a critical factor in determining whether a firm engaging in such activities is eligible for the 20 percent pass-through deduction.  However, further clarification or guidance is needed to ensure that non-bank mortgage banking firms – known as Independent Mortgage Bankers or IMBs – are fully and transparently eligible for pass-through treatment, consistent with statutory language and intent.
CHLA requests that the final rule include explicit clarifying language or guidance stating that:
(1)   Independent mortgage banking firms (IMBs) are not considered a “Specialized Service Trade or Business” – and therefore are eligible for the pass-through deduction, and
(2)   The following customary activities of an IMB are excluded from the term “Financial Services” [as defined in Section 1202(e)(3)(A)]:
(A)  Mortgage loan origination, regardless of whether a loan is held in portfolio or federally guaranteed (e.g. by FHA or Fannie Mae or Freddie Mac)
(B)   Sale of mortgage loans – including, for example, through issuance of Ginnie Mae securities or Fannie Mae or Freddie Mac mortgage-backed securities (MBS)
(C)   Mortgage loan servicing and the sale of mortgage servicing rights (MSRs)



1.   IMBs are NOT a Specialized Service Trade or Business
There are a number of reasons why IMBs should be explicitly recognized as being eligible for pass-through deduction treatment in the final rule:
A. The core activity of an IMB is making (originating) a loan.
The proposed rule makes it clear that “making a loan” is not a Financial Service.  The core activity of an IMB is making (originating) a loan.  Therefore, an IMB is not a Specialized Service Trade or Business (SSTB) for the purpose of the passthrough deduction eligibility.
B. IMBs do not fall into any of the enumerated Categories in Section 1202(e)(3)(A):
Section 1202(e)(3)(A) contains the definition of an SSTB, and lists the performance of services in a number of areas, including “health, law, accounting, actuarial science, performing areas, consulting, athletics, financial services, brokerage services. . .”  IMBs do not engage in the performance of services in any of these enumerated areas, including “financial services” (as noted in section A just above).
C. The Principal Asset of an IMB is NOT the Reputation or Skill of Its Employees or Owners.  Section 1202(e)(3)(A) contains the definition of an SSTB, and additionally refers to “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.”
Mortgage origination involves a wide range of responsibilities and services provided to the customer – including a complex underwriting process, a detailed loan closing process, and the financing of the loan.    An IMB’s ongoing success with consumers is not principally related to the reputation or skill of its owners or employees – but instead is highly dependent on the ability to deliver competitive mortgage rates in a highly competitive market, and also on ongoing consumer perceptions of a firm’s ability to efficiently carry out all the activities described above.
Moreover, the principal assets of an IMB are not the reputation or skill of their employees or owners.  Instead, an IMB’s principal assets are: (1) their licenses to do mortgage origination in each state in which they operate, (2) their technology, underwriting systems, and product offerings, and (3) their ongoing relationships with a wide range of market participants.  The latter includes relationships with loan insurers such as the Federal Housing Administration (FHA), Rural Housing Service (RHS), Veterans Administration (VA), Fannie Mae, and Freddie Mac; with aggregators; with investors; with private mortgage insurers (PMIs); and with warehouse lenders.
D. IMBs Fall into the Excluded SSTB Categories Lists in Section 1202(e)(3)(B) through (E)
An IMB’s core activity of making (originating) a loan falls into the category of “financing” in Section 1202(e)(3)(B).  Therefore, as one of the specific categories listed in this subsection and not listed in the definition of an SSTB, it is clear that IMBs should be explicitly recognized as being excluded from the definition of an SSTB.
2.  The Following Customary Activities of an IMB Should Be Explicitly Excluded from the Term “Financial Services” [as defined in Section 1202(e)(3)(A)]:
 A. Mortgage Loan Origination as an Activity is not a “Financial Service”
As noted, the term “making a loan” is not considered a Financial Service.  This seems clear with respect to entities that directly extend credit through their own funds, and mortgage bankers do close the mortgage loans with their own funds.  However, clarification would be helpful in the context of mortgage loan origination in the common occurrence in which the loan is not ultimately held in portfolio by the IMB, but is instead backed by the guarantee of a governmental housing program (FHA, RHS, or VA) or guaranteed by Fannie Mae or Freddie Mac.
For the purposes of the pass-through deduction, there is no meaningful difference between originating a mortgage loan that will be held in portfolio and originating a loan that is guaranteed in that manner.  Therefore, the final rule should make it clear that “making a loan” includes all mortgage loan originations.
 B. Sale of Originated Mortgage Loans Do Not Constitute a “Financial Service”
The proposed rule makes clear that a wide range of securities activities are considered Financial Services – including investing and investment management, trading, and dealing in securities, partnership interests and commodities, as well as acting as a financial advisor or wealth planner, managing retirement plans, and engaging in mergers, acquisitions, dispositions, and restructurings.
Such sales are sometimes executed through the securitization of the mortgage loans.  Moreover, mortgage loans held as assets for eventual sale to investors in the ordinary course of a firm’s trade or business must be marked to market pursuant to Section 475 of the Internal Revenue Code.  Therefore, CHLA is requesting clear guidance that sales of mortgage loans not be inappropriately considered a securities transaction, even though the execution of such sale may involve a securitization of some form of mortgage backed securities.
Classifying the sale of originated mortgage loans as a financial service would clearly be inconsistent with the purpose of Section 199A, which as the proposed rules notes “is to provide a deduction based on the character of the taxpayer’s trade or business.”  While the method of execution of selling off a mortgage loan (or pool of loans) may involve the issuance of securities (e.g. GNMA securities or Fannie or Freddie mortgage-backed securities (MBS)), the statute is clear that in order to be excluded from pass-through treatment, the firm must ALSO engage in activities that involve the “performance of services” on behalf of other parties.
In the process of selling off mortgage loans, an IMB is not acting as a securities firm to execute the MBS issuance, but instead typically utilizes an independent securities firm.  Therefore, such activity does not involve the “performance of services” for third parties on the part of the IMB.  MBS securitization is for the sole purpose of selling an IMB’s loans that they own – not to make money by performing a service for, and charging a fee to, a third party.  An IMB sale of loans involving a securitization in this manner is thus not a performance of services for a third party.
C. Explicit Guidance on Mortgage Servicing and Sale of Mortgage Servicing Rights (MSRs)
Mortgage loan servicing is integrally tied to mortgage loan origination.  This activity includes receiving monthly payments, remitting such payments, making advances when a borrower does not make a payment, and engaging in loss mitigation.  As such, there appears to be no basis under which to characterize this activity as a Financial Service or to characterize firms that engage in this as SSTBs.  Therefore, to provide maximum clarity, the final rule should state explicitly that mortgage servicing  – like mortgage origination – is not considered to be a “financial service.”
A similar analysis applies to the sale of mortgage servicing rights (MSRs) as discussed in Section B above for the sale of mortgage loans.  Therefore, the final rule also should state explicitly that that the sale of MSRs does not constitute a “financial service” – even when it is executed through a securities transaction by a third party.



IMB vs. Bank Treatment – Comparability, Competitive Fairness, and Consumer Impact
The proposed rule makes owners of banks eligible for pass-through treatment (in part, through its reference to “banking”) – while IMBs are not specifically cited in the list of excluded activities.  However, both banks and IMBs engage in the same types of mortgage activities – originating, servicing and selling off mortgage loans (including securitizations such as through GNMA).  Banks also engage in a wide range of other activities that IMBs do not, including offering other financial products and utilizing the securitization of loans through asset-based financing (such as credit cards).  Finally, in the same way that banks’ activities are constrained by bank regulators and charters, so too are IMBs constrained in what they can do through their state regulators.
For all these reasons, if the rule is going to explicitly make banks eligible for pass-through treatment, it should explicitly make IMBs eligible.
Moreover, failing to do so would create an unfair competitive advantage for banks relative to IMBs with respect to mortgage origination and servicing.
This in turn, would hurt consumers by making it harder for IMBs to continue their market leadership role in providing access to mortgage credit and personalized service.   In the years after the 2008 Financial Crisis, IMBs have significantly increased their origination activities as banks retreated from the business – principally because of IMBs’ commitment to mortgage lending as their only line of business and to personalized customer service.  Creating a disparate tax treatment relative to banks would hurt IMBs in their ability to continue to provide a leadership role with consumers in meeting this access to credit function.
Full IMB Eligibility for the Pass-through Deduction is Consistent with Statutory Objectives
Making IMBs fully and explicitly eligible for the 20 percent pass-through deduction treatment is wholly consistent with the underlying statutory objectives of this deduction, which as noted in the proposed rule, are intended to benefit a wide range of businesses by encouraging economic activity and job creation:

  • Mortgage origination by IMBs creates significant economic activity.   Mortgage loans:

(1) Facilitate new home construction and resulting economic activity;
(2) Facilitate home purchases, which typically result in ancillary purchases such as furniture, refrigerators, washer/dryers, and other items generally associated with new home purchase, and
(3) Reduce mortgage payments through re-financings, which free up a homebuyer’s disposable income, enabling other consumer purchases.

  • IMBs are true small businesses, with an orientation that emphasizes personal relationships with borrowers and local community involvement.
  • IMBs create a significant number of direct jobs, through extensive hiring to meet their labor intensive activities of mortgage loan origination, underwriting and servicing.

Thank you for your consideration of these comments and request.