As if the winter months were not stressful enough with holiday parties, gift buying and all the fun things that go along with that time of year, mortgage servicing professionals are faced with the looming Dec. 31 deadline for mountains of work that needs to be completed before the end of the year.
Year-end reporting and property tax payments make up the lion share of that work, so preparation should start by late summer or early fall to ensure that customer expectations are met and to avoid those difficult calls after the first of the year when customers are preparing their income taxes. Approximately 40% of tax payments normally fall into the fourth quarter processing window. This includes payments to tax agencies with due dates in the current year, as well as those with tax due dates extending into the early part of the following calendar year. Nearly all servicers seek to satisfy customers who want to ensure an income tax deduction for the payment of their property taxes when the current year’s bill is due early into the following year. These are commonly referred to as “early year-end” or “false year-end” states or agencies.
Several factors weigh into the decision to pay tax bills earlier than an agency’s due date to secure 1098 reporting and the resulting eligibility for an income tax deduction for the payment of property taxes. These include the potential customer demand for those payments, customary payments in the industry and the preference of the agency to receive payments early from mortgage servicers.
The most customer-satisfying approach is to ensure continuity year after year. Interruption of the timing of payments from one year to the next will cause customer frustration and calls to customer service if a customer experiences a year without an eligible deduction, even if they have a year with two eligible deductions. To avoid this negative customer experience, the best practice is to select states or agencies where early payment is customary, and the historical demand has been presented to justify payment of all customer bills in those areas year after year. States with early year-end payments include Michigan, Mississippi, Nevada, North Carolina, Alabama, North Dakota, New York, Louisiana, South Carolina, Tennessee, Texas, Wisconsin and Connecticut. Timing of payments to agencies in these states can vary from lender to lender. Bills for some of these customary agencies are released in the fall but some can be released into the month December, which of adds some challenges for servicers faced with a short window to procure the bills and ensure disbursement by Dec. 31.
Wisconsin has state-wide requirements for customers where they are entitled to select payment options. Two of these options require the bills to be disbursed in December. Customers can elect to have their escrow funds for taxes paid directly to them by December 18 each year or elect to have their funds paid directly to the tax offices by Dec. 31. The third option requires the bills to be paid by the statutory date in January. Some servicers elect to minimize any customer concerns in Wisconsin by verifying the selected option by mail earlier each calendar year.
In addition to Wisconsin, some states and agencies require mass payers to remit payment before year-end. Most notably North Carolina and Alabama have such requirements.
Complications can occur if the loan boarding process is not aligned with servicing. If your business originates new loans, the servicing group should partner with the various origination channels as much as possible to ensure that the practice of determining when a bill will be paid at closing or not paid aligns with the servicing unit’s year-end payment practices. If an originator fails to ensure the payment of a bill at closing that is customarily paid by the servicer at year-end, the customer may miss out on a deduction for their property taxes during the year they closed on the loan. This will result in two deductions the following year. They may also face hardship if they pay a bill at closing that the servicer typically pays in the early part of the year. In this case, the customer would qualify for a deduction for the tax paid at closing but miss out on a deduction for the entire following year. For example, let’s say a customer in the state of Connecticut is closing on their loan on Dec. 20, 2019. To be helpful and to secure a 2019 deduction for property taxes, the title company elects to collect and pay the tax bill due Feb. 1, 2020, at closing. This servicer does not treat Connecticut agencies as early year-end payment agencies and therefore will not pay another tax bill until Feb. 1, 2021. This customer will then not have a qualifying deduction for the 2020 tax year.
Servicing acquisitions also create complications for year-end tax payments. There is a strong likelihood that the retiring servicer’s selection of states to be paid early at year-end does not align perfectly with those of the acquiring servicer. To avoid negative customer reaction, servicers must be cautious about their loan boarding approach for loans in these states and agencies. Due diligence and servicing transfer instructions always need to identify the states and affected loans where discrepancies exist from one servicer to another. Like the new loan origination example, variances from transferring to purchasing servicer can lead to customers who will lose a year of eligibility for deduction and/or a year with two eligible deductions.
A consumer’s monthly mortgage payments will change if the scheduled date to pay taxes changes from year to year. Where a discrepancy exists, early communication to those affected customers will alert them proactively to the change and possibly prevent angry calls to customer service. It’s a good practice to send letters, notices or alerts where possible to customers both at the time of a service transfer and prior to the new escrow analysis. Running a new escrow analysis at the time of transfer can minimize the effect on the customer’s escrow account and reduce the risk of escrow shortages and advances.
A related issue for customer service and escrow departments to face is related to what is and is not deductible. First and foremost, customers should be directed to their tax professionals for expert advice on filing their income tax returns. However, a correct 1098 report will minimize customer confusion and difficult calls.
Generally, the servicing system should be set to ensure that the produced 1098 does not include bills paid from escrow by the tax department that are not eligible for deductions. Because the payment of bills other than ad valorem real estate taxes is commonly paid from escrow as tax bills, servicers must ensure that such bills are not reported as taxes on the 1098 form sent to customers. Per the Internal Revenue Service (IRS) Publication 17, state and local real estate taxes along with a tenant’s share of real estate taxes paid by a cooperative housing corporation are deductible. Taxes for local benefits, such as assessments for streets, sidewalks, water mains, sewer lines, public parking facilities and similar improvements are not deductible. In addition, itemized charges for services cannot be reported as deductible on the 1098 form. This includes items that are a unit fee for the delivery of a service, such as a usage fee per gallon for water usage, periodic fees for residential services, including trash collection or flat fees charged by a municipality for needed maintenance. These are not eligible for deduction even if they are paid directly to the tax authority. Homeowner association bills, which are often paid from a customer’s escrow account, should also not be included as a tax on the 1098. Under IRS guidelines, these fees are not eligible for deduction.
A final critical step is to ensure that taxes intended to be eligible for deduction be disbursed from the escrow account in that calendar year. This ensures that 1098 reporting, which is relied on for validation by the IRS, reflects a payment made in the appropriate tax year.
Early planning for the tax year-end cycle can be a significant amount of work. Aligning dates, communicating with customers and ensuring proper system set up for year-end reporting can take time. However, done properly, the reduction of customer complaints as a result of this work can make for a very happy New Year for mortgage servicers.