Here’s an almost completely unremarked-upon side effect of the foreclosure fraud settlement: the tax implications. If you are one of the lucky few eligible to receive a principal reduction from the settlement, when the banks aren’t paying off their penalty bulldozing homes and waiving deficiency judgments, you have to reckon with this: because of the expiration of a Congressional law, every dollar you receive in principal reduction would be viewed for tax purposes as income, and thusly taxed. Most of the people needing a principal reduction are in dire financial straits; they wouldn’t need a write-down otherwise. So now, we’re going to hit them with a big tax bill that they can pay for with money they don’t have. A $50,000 principal reduction, entirely possible under this settlement, could lead to a $15,000 levy or more, depending on the income level and tax situation of the borrower. Even the $2,000 “sorry you lost your home” payments envisioned by the settlement could be subject to taxation, reducing their impact.

Democratic Reps. Jim McDermott, John Larson and Shelley Berkley, members of the tax-writing House Ways and Means Committee, have recognized this, and filed legislation to remedy it, which they’re calling the “Homeowners Tax Fairness Act.” Every Democratic member on Ways and Means endorsed it. This is an excerpt from their press release:

Representatives Jim McDermott (D-WA), John Larson (D-CT) and Shelley Berkley (D-NV) introduced the “Homeowners Tax Fairness Act” today to protect homeowners and servicemembers who were wrongly foreclosed on and entitled to relief under the historic national mortgage settlement from additional tax burdens.

Homeowners receiving relief in the form of mortgage debt forgiveness and direct cash payments for wrongful foreclosure could be subject to federal income tax. Moreover, additional taxes would be owed on the payments made to servicemembers who were wrongfully foreclosed on while deployed overseas.

To prevent that injustice, the Homeowners Tax Fairness Act would extend the exclusion for debt forgiveness on a primary residence throughout the term of the settlement agreement, and exclude the relief payments from income for homeowners and servicemembers.

Specifically, the Homeowners Tax Fairness Act extends a 2007 law that would exclude principal reduction from being counted as income for a particular borrower. It would also exclude the $2,000 cash payments as income, and the very large payments to servicemembers – as much as $116,000 – for wrongful foreclosures and violations of the Servicemembers Civil Relief Act. Finally, they would deny the banks a tax deduction for those payments to servicemembers.

Normally I wouldn’t report on a bill filed in the Republican House by Democratic members. But think about how absurd this all is. Homeowners were ripped off, often by faulty appraisals artificially increasing the value of their home at purchase. They were steered into bad loans at the height of the bubble, and then the bubble collapsed. Now they are massively underwater, and they lost all their equity in the home. It turns out that was largely done illegally. And now if they are lucky enough to get a chance at relief, surprise! They’ll get a hefty tax bill they can’t pay for the amount of restructuring of their loan.

House Republicans have shown themselves to be very sensitive to at least the plight of servicemembers who were wrongfully foreclosed upon by the banks. So that could be the hook to get this into law. It’s urgently needed to prevent yet another indignity from being put onto homeowners.