1099-C: The Worst Tax Mess of the Year?

It’s perhaps the biggest tax mess of 2012: An estimated 6.3 million 1099-C forms reporting cancellation of debt income have gone out to taxpayers. Some of those forms are being sent to consumers for very old debts that they never thought they would hear about again. To make the situation worse, the IRS is arguably providing inadequate guidance to taxpayers, and even tax professionals have different opinions about how to deal with them.

Why now? Why would creditors suddenly be sending out these forms for ancient debts? “There are all these new 1099 reporting requirements coming out this year,” says Kay Bell, contributing tax editor for Bankrate.com and author of The Truth About Paying Fewer Taxes. There is a push by the IRS to “get more information to get people to pay what they owe regardless of the source.

Here are a just a few comments and questions we’ve received in response to stories on this topic at Credit.com:

I just received a 1099-C from Bank of America. I do not remember the debt, but I have had no dealings with them for more than six years. The statute of limitations on credit card debt in Florida is 4 years. Is there a time frame within which the banking institution has to “forgive” a debt, and a time limitation on when they may file a 1099-C with IRS? —John

I have received three 1099-Cs from a debt collector (Asset Acceptance). I do not recall getting any mail from this company and they are not on my credit reports. I have read a lot of conflicting advice about whether or not this is even a legitimate 1099-C since they are a junk debt buyer. —Charlotte

I’m glad I found this article! I received a 1099-C today for an old credit card debt which dates back to 2001. This date is way past my state’s statute of limitations which until last year (4/11) was 3 years but was changed to 6 years. The debt is uncollectible and unreportable so how can they forgive something they have no right to collect? —Nancy

“If ever the term “blast from the past” were applicable to a section of tax law, the provisions for cancellation of debts would rank near the top,” says Pete Sepp, Executive Vice President of the National Taxpayer’s Union. “Taxpayers can receive some nasty tax surprises from this area of law, some of them dating back quite some time. Also, this area of tax law is among the most complex for individuals and their preparers, definitely in league with the Alternative Minimum Tax and the latest investment income reporting requirements.”

The National Taxpayer Advocate, the independent advocacy arm of the IRS, has noted that 1099-Cs for Cancellation of Debt Income (CODI) can be a burden to taxpayers, stating in a report to Congress that “creditors sometimes make errors on the form that debtors then may have to wage an uphill battle to correct.”

It can be a minefield, agrees Jennifer MacMillan, an enrolled agent and member of the National Association of Enrolled Agents. “There are so many reasons why a 1099-C can be wrong.”

When Are Lenders Supposed to Send 1099-C Forms?

I just received a 1099-C for a relatively small amount, from Capitol One. My credit has been excellent for years, so I called them to find out where this came from. It turns out it was from a credit card I had in 1986, and which was charged off in 1989. But the official debt forgiveness date is 12/31/2011. I haven’t had contact with Capitol One, of any kind, in decades. My question is: isn’t there a statute of limitations on these “forgiveness” shenanigans? —Jim

In the 2012 instructions for Form 1099-C that the IRS provides as guidance to creditors, it states:

“A debt is deemed canceled on the date an identifiable event occurs or, if earlier, the date of the actual discharge if you choose to file Form 1099-C for the year of cancellation.” In addition to the discharge of a debt in bankruptcy, one of the identifiable events is:

“A cancellation or extinguishment when the statute of limitations for collecting the debt expires, or when the statutory period for filing claim or beginning a deficiency judgment proceeding expire.”

So far, so good. It sounds like the 1099-C should be filed if the statute of limitations for the debt has run out. (The statute of limitations is a matter of state law, and varies depending on the type of debt.)

But wait. The IRS then throws in this caveat:

“Expiration of the statute of limitations is an identifiable event only when a debtor’s affirmative statute of limitations defense is upheld in a final judgment or decision of a court and the appeal period has expired.”

So it appears the statute of limitations only comes into play if the debtor has been sued for the debt, raised the statute of limitations as a defense against the collection of the debt, and the creditor did not appeal the decision.

The IRS then describes another identifiable event:

“A discharge of indebtedness because of a decision or a policy of the creditor to discontinue collection activity and cancel the debt. A creditor’s defined policy can be in writing or an established business practice of the creditor. A creditor’s established practice to stop collection activity and abandon a debt when a particular nonpayment period expires is a defined policy.”

This is of no help to taxpayers, of course, because they would have no way of knowing what the creditors’ policies are. So let’s move on to another one:

“The expiration of non-payment testing period… This event occurs when the creditor has not received a payment on the debt during the testing period. The testing period is a 36-month period ending on December 31, plus any time when the creditor was precluded from collection activity by a stay in bankruptcy or similar bar under state or local law.”

Bingo! If none of the other triggers for sending a 1099-C apply, it sounds like the creditor must send one out three years after there has been no payment made on the debt for three years.

Not so Fast (cont.) »

Image: Chloë Rae, via Flickr.com