Notice of Proposed Rulemaking to establish regulations to implement the 20 percent deduction for Qualified Business Income

CMLA Advocacy

The Hon. Steven Mnuchin
Secretary, Department of the Treasury
1500 Pennsylvania Ave, NW
Washington, DC 20220

The Hon. Charles Rettig
Commissioner, Internal Revenue Service
1111 Constitution Ave, NW
Washington, DC 20224                                                                                                        Read In PDF

Dear Gentlemen:
The Community Mortgage Lenders of America submits 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).

The CMLA represents both community banks and non-bank mortgage companies; in both categories, our members are very small in scope compared to large banks and finance companies paying corporate rates. We are pleased that community banks already have eligibility for pass-through treatment; as part and parcel of this, The CMLA appreciates language in the proposed rule that excludes “the making of loans” from the definition of “Financial Services.” The primary activity of mortgage banking, whether done by community banks or community Independent Mortgage Banks (IMBs) is making mortgage loans to consumers, 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.

We ask you to ensure, through addition guidance and regulations, that IMBs too are fully and transparently eligible for pass-through treatment, consistent with statutory language and intent. Often a misunderstanding around IMBs exists in Washington policy circles; these community organizations do not have federal deposit insurance but in many communities are a vital local source of home loans, especially in neighborhoods where no large banks or finance companies exist. They receive regulatory scrutiny from a host of federal agencies and state governments. To clarify, IMBs are not mortgage brokers; they make loans from their own sources of liquidity and are on the hook financially if loans perform poorly. They deserve the ability to thrive and compete effectively with those larger corporations that received significant rate reductions in this tax reform bill.

The CMLA 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 raising liquidity for the express purpose of making (originating) a loan directly to consumers. 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 the processing of complex documentation establishing the viability of the borrower to repay the loan within the determined parameters of the program requested, as well as adhere to all of the regulatory requirements established by the GSE or Agency in which the program was established, a complex underwriting process, a detailed loan closing process, and the financing of the loan. Each step must conform to the regulatory requirements established on both the federal and state levels. 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, risk management 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 and sold to a third party; indeed, many of our small banks do not keep their originated loans on their balance sheets either. Therefore, the final rule should make it clear that “making a loan” includes all mortgage loan originations, regardless of where the loan rests ultimately.

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, CMLA 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.

Making loans and the sale of a bank’s loans and participations in loans, just like taking deposits, is a long-standing, fundamental part of the business of banking and is significantly regulated by governmental agencies as one business line, involving safe and sound lending practices, not multiple lines.

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.

Mortgage banking companies are certainly in the business of financing real estate as described in Section 1202(e)(3)(B).

If Congress had intended to include the business of financing within the definition of “specified service trade or service,” it would have extended the scope of its cross reference to include Section 1202(e)(3)(B). But Congress did not do so. As stated above, Independent Mortgage Banker firms are not performing services in the field of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services.,
The appropriate lens for interpreting the application of new Section 199A is the congressional intent to maintain equal footing between C corporations and pass-through entities that compete with one another. Mortgage banking companies frequently are organized as pass- through entities and they compete directly with national mortgage banking companies with offices across the United States as well as with banks and other lending institutions engaged in financing.

Therefore, interpreting Section 199A in a way that would have the effect of reducing tax rates for one group engaged in financing real estate (C corporations) while not reducing rates for another group engaged in similar financing activities (mortgage banking companies organized as pass-through entities) would be fundamentally inconsistent with the intent of Section 199A. Moreover, that outcome could detrimentally change the lending landscape, for example, by reducing access to capital outside of the nation’s financial centers—and directly reducing capital and economic opportunity to areas of the US struggling to catch up with wealth coastal urban areas—which would be a result clearly contrary to congressional intent.

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:

• The “Main Street” organizations must not lag behind tax (and regulatory) treatment of large, publicly-financed and taxpayer-backed mega banks.

• 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.

For more information, please contact Ed F. Wallace, Jr. PhD, (770) 330-5176,
Thank you for your consideration of these comments and our request.

CMLANotice of Proposed Rulemaking to establish regulations to implement the 20 percent deduction for Qualified Business Income