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"Investor incentive payments" made by the federal government's Home Affordable Mortgage Program are not generally taxable to borrowers participating in HAMP's Principal Reduction Alternative, the IRS said in guidance released last week.

The incentive payments are made directly to the mortgage holder. These payments aren't includable in the borrower's gross income. However, if the amount of principal reduction exceeds the total amount of the investor incentive payments, the borrower may be required to include that excess amount in gross income.

If there is an excess, it would be reported as income from the discharge of indebtedness. "However, many borrowers will qualify for an exclusion from gross income," the IRS says.

The guidance is in Revenue Procedure 2013-16.