The Taxpayer First Act and the Impact on Secondary Market Participants

The Taxpayer First Act (the “Act” or “TFA”) imposes new limits on the disclosure of US taxpayer tax information obtained on or after December 28, 2019.  The Act is designed, among other things, to overhaul and modernize operations at the Internal Revenue Service (“IRS”).  One provision of the TFA has a direct impact on a recipient of taxpayer return information obtained directly from the IRS.  Although questions remain about the reach of the new rule, it is already finding its way into structured finance and secondary market transactions.

Section 6103 of the Internal Revenue Code (the “Code”) governs the confidentiality and disclosure of tax returns and the information contained in tax returns.  The TFA, effective as of December 28, 2019, amends Code Section 6103(c) to require taxpayers to consent to: (i) the particular purposes for which the recipient will use the taxpayer’s tax return information (the recipient may not use the information for any other purpose); and (ii) the sharing of any information from the tax return with other persons.  Prior to the TFA amendment, Code Section 6103(c) simply authorized the IRS to release a taxpayer’s tax return information to parties designated by the taxpayer to receive it.

It is common in connection with the origination and servicing of consumer and mortgage loans for a lender or servicer to obtain a borrower’s tax transcript information directly from the IRS.  Generally, mortgage lenders require borrowers to sign an IRS Form 4506-T during the origination process, which gives the lender the borrower’s authorization to obtain transcripts of the borrower’s tax returns directly from the IRS.  As a result of the TFA’s amendment to Code Section 6103(c), lenders now are required to explain to the borrower the purposes for which the lender will use the borrower’s tax transcript information, and to obtain the borrower’s express consent to allow the lender to share the tax transcript information with other persons.  The Act does not dictate particular language that must be used to comply with these requirements.

Borrower information obtained during the origination of a loan becomes a permanent part of a loan file, is used by servicers in servicing a borrower’s loan, and usually is transferred (in one form or another) each time a loan is sold or securitized.  Therefore, it is important to consider Code Section 6103(c)’s new restriction on sharing this information in the context of entering into a transaction that leverages or transfers a pool of loans. In particular, originators should reduce the risk that every party in the life cycle of a loan may need to separately obtain a borrower’s consent to transfer tax transcript information by obtaining broad use and disclosure rights from a borrower during the origination process.

Mortgage industry participants have begun the process of creating disclosures and consent language that could be provided by the mortgage originator prior to obtaining the borrower’s tax transcripts, which would allow all subsequent recipients of the tax transcripts in the loan file to rely on that consent. The Mortgage Industry Standards Maintenance Organization  (“MISMO”) released form language, currently being implemented by industry participants, that covers a range of possible uses of the tax transcript information, including origination, insuring, servicing, selling, securitizing and marketing, and lists a number of parties with which such information could be shared, such as the lender’s service providers, owners of the loan, holders of a mortgage-backed security, mortgage insurers, and service providers to those entities.  While a lender remains free to draft its own consent language, many mortgage lenders and their document providers have incorporated, with permission, the MISMO language into their disclosure packages to ensure a borrower is broadly informed of the express purposes for which tax transcript information will be used and the lender obtains express consent for such information to be shared with a range of identified parties prior to obtaining tax transcripts from the IRS.

So what does this mean for an investor in loans?  Assuming an originator makes adequate disclosures and obtains the borrower’s consent to the lender’s sharing of the tax transcript information with secondary market participants, all subsequent recipients of the information should be covered by that initial consent and can receive the tax transcript information.  As a result, in the mortgage industry, for example, we are seeing that purchasers of mortgage loans originated on or after December 28, 2019 and subsequent securitizers of those loans are performing diligence or obtaining representations confirming that mortgage originators obtained borrower consent to allow investors to receive tax transcript information.  If so, no action is required by the investors.

To the extent a lender obtained tax transcripts from the IRS prior to December 28, 2019, the consent language is not required, which means that investors may receive tax transcript information without restriction under the Act.  To the extent investors hold loans or asset-backed securities contain loans that were closed before December 28, 2019, the TFA requirements are not applicable to the tax transcript information obtained prior to that effective date.

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