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Saturday, April 13, 2013

Tax law oddity on cancellation of debt

In 2012, a case was decided by the Tax Court where the taxpayer challenged a Form 1099-C he received (Stewart, TC Summary Opinion 2012-46). The taxpayer did not include the 1099-C (for cancellation of debt income) on his return because it was the wrong year. The statute of limitations on the debt had terminated years earlier.

The debt had been sold by the original lender to a collection firm and that firm sold it to another firm at a time the statute on collection had already expired. So, why would a collection firm purchase expired debt?  Well, because they can call and mail to the borrower and hopefully annoy and scare them enough that they will get some money out of them.  Well, this borrower sent a letter to that firm telling them to stop and they did. And they issued him a 1099-C. That may seem surprising since the debt expired years earlier.

The IRS respected the 1099-C and took the taxpayer to court. The court determined that the burden of showing that the 1099-C was correct fell upon the IRS. The facts revealed that the 1099-C probably should have been issued in 1999 (not 2008)!

The regulations governing the issuance of a 1099-C allow for one to be issued after 36 months of inactivity regardless of whether the debt has truly been cancelled.  That is really odd (but apparently done to avoid penalty for the issuer/lender).

The IRS had acknowledged that just because you get a 1099-C doesn't mean your debt has been discharged. As they stated in Information Letter 2005-207:

q“The Internal Revenue Service does not view a Form 1099-C as an admission by the creditor that it has discharged the debt and can no longer pursue collection. Section 1.6050P-1(a) provides that, solely for purposes of reporting cancellation of indebtedness, a discharge of indebtedness is deemed to occur when an identifiable event occurs whether or not an actual discharge of indebtedness has occurred on or before the date of the identifiable event.” 

The IRS recently sought guidance on some aspects of the issuance of 1099-C. I drafted the comments the AICPA submitted. We called for terminating the 36-month rule and only having a 1099-C issued if the debt has been legally cancelled.

This should make it easier for the taxpayer/borrower and prevent loss of tax dollars to the fisc. For example, in the case described here, the discharge of debt income was never picked up into income.

Stewart likely could have avoided an audit and a trip to court by reporting the 1099-C on his return, but then backing it out with an explanation that it was issued in error and that the debt was cancelled in an earlier year. This would then enable IRS computers to match the 1099-C it received with income on the borrower's return.

This is just one of a few weaknesses in the tax system in how it addressed income from discharge of indebtedness. These rules can be complicated in practice.

But an tax system that allows a borrower to receive a 1099-C reporting cancellation of debt income that does not necessarily really mean that the recipient has such income in that year and that the lender may still try to collect is just odd.

What do you think?  Any other oddities you've run across lately?


Unknown said...

The Government, and governments, (all parties) have backed-off on the income tax and switched to a revenue system based on employment taxes, sales taxes, fines, and 2013 tax brackets. If you look at the big picture, both parties want more of your money. Who knows, maybe they deserve it.

Unknown said...

1099-c form is filed for the purpose of cancellation of debt. It has many reason as the debt was discharged in bankruptcy. In this situation 1099-C tax form is required. 1099 software makes it quickly and easily to file.

Unknown said...

There are a number of "oddities", as you put it, in tax law. Some of these shortcomings can actually work to the tax payer's advantage while seeking tax debt relief, especially if they enlist the help of a reputable and effective tax service provider for representation.

Unknown said...

Prepare your federal and state tax forms with 1099 Electronic Filing software. This software helps us to makes tax filing easy and stress free. It is available at affordable price with attractive new features.

Anonymous said...

It's double dipping and keeping the american people down even more. If they write off and monies for their business then it shall be reported to your credit bureaus and a $0 balance write off and to the irs as income because you assume as income and pay the taxes. That's fair- and we all know that Irs is crooked and the creditor do what they want