IRS Debating Whether to Punish Largest Tax Cheats in History
A recent article from Reuters illuminated an interesting dilemma that the IRS is currently facing in reference to what may be the largest example of tax fraud in US history. The alleged fraud involves the improper handling of the transfer of mortgages into and out of a legal entity known as a Real Estate Mortgage Investment Conduit (REMIC), investments which totaled $3 billion in 2010 alone.
The IRS allows for special tax treatment of REMICs, exempting the securities created by the REMIC from double taxation. The idea is that the REMIC will simply act as a means of securitizing a block of mortgages into something an investor would be inclined to buy. No taxes are imposed because the REMIC is supposed to be a static entity holding a single block of debt obligations, not a business actively trading in property.
This special tax treatment comes at the cost of a strict regulatory framework. REMICs are required to formally transfer all mortgages into the entity on the day the REMIC is created, or at least within a 120 day grace period. Additionally, REMICs must be carefully managed so that all proper paperwork is executed in order to guarantee that the chain of title for each individual mortgage remains clear. If the strict rules are not adhered to, the tax code imposes a 100% tax on all income plus other potential penalties.
Evidence exists demonstrating that numerous REMICs have not been in compliance with the tax code, operating more like businesses than the conduits they are supposed to be, directly in violation of the requirement that all mortgages be placed into the entity at its inception. Not only that, the sloppy procedures and bookkeeping of the REMICs resulted in problems with the chain of title for these properties. In other words, it is difficult to determine who owns the properties that have passed through these non-compliant REMICs, making them difficult to foreclose or sell. Worse yet, REMICs have been implicated in the creation of fraudulent assignments and other essential documents.
The problem is that these violations appear to be pervasive. If the IRS were to crack down on the offenders, we would likely experience a banking collapse rivaled only by the collapse experienced during the Great Depression. As Adam Levitin, a Georgetown University Law School professor, stated in his interview with Reuters, IRS non-enforcement in this case would effectively be “a backdoor bailout of the financial system.”
REMIC investors angry about how these entities were operated should file their suits soon, as they may not have much time to do so. As April Charney, a Jacksonville, FL foreclosure defense expert, noted, the REMIC establishing agreements usually set a short time limit for investor suits for deficiencies relating to turning over promised mortgages.
How the IRS proceeds will have profound effects on our financial and regulatory system. If they choose to bring the perpetrators to justice, our nation will likely suffer an unimaginable financial collapse. On the other hand, if they do not choose to bring these individuals to justice, the precedent set regarding the consequences for non-compliance with the tax code may be grave indeed.