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."
[Infographic: What to Do If You Get a 1099-C]
FREE TOOL: CHECK YOUR CREDIT Credit.com's Credit Report Card
Check your credit bureau profile for free with this great tool. See your detailed credit evaluation, expert advice on managing your credit, and unlimited free updates every 30 days. Get Started Here »
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 Phil 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."
[Credit Check Tool: Try Credit.com's Free Credit Report Card]
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.
But not so fast. The IRS adds another caveat to this one as well:
Check your credit for free with this great tool from Credit.com. It offers expert advice on how to manage your credit. And you can return every 30 days for unlimited free updates.
"The creditor can rebut the occurrence of this identifiable event if: 1. The creditor (or a third party collection agency on behalf of the creditor) has engaged in significant bona fide collection activity during the 12-month period ending on December 31, or 2. Facts and circumstances that exist on January 31 following the end of the 36-month period indicate that the debt was not canceled. Significant bona fide collection activity does not include nominal ministerial collection action, such as an automated mailing. Facts and circumstances indicating that a debt was not canceled include the existence of a lien relating to the debt (up to the value of the security) or the sale or packaging for sale of the debt by the creditor."
So now the IRS seems to be indicating that if the creditor packaged the debt for sale, the requirement to send the 1099-C after 36 months of non-payment does not apply. Again, though, this is of little help to taxpayers. How will they know if that occurred, much less challenge it?
[Credit Check Tool: Try Credit.com's Free Credit Report Card]
Taxpayers Want Answers: Good Luck With That In researching this story, I queried the IRS multiple times with no response. I also reached out to the Senate Finance Committee, under whose jurisdiction the IRS falls, and attempted to reach the Taxpayer Advocate, which has written about this issue in reports to Congress. I received no reply from any of these agencies.
I also reached out to a number of tax professionals with varying degrees of success. Some gave conflicting advice while others felt the IRS has not provided adequate guidance to taxpayers on this specific issue. Most tax advisors encouraged taxpayers to get professional advice if they have received a 1099-C for an old debt. While I agree wholeheartedly, it is troubling that the taxpayers who would most need professional assistance to navigate this complex issue are the ones who may be least able to afford it. After all, financial difficulties are what led to them getting a 1099-C in the first place. Indeed, a few Credit.com commenters told us that they don't normally have to file tax returns due to their limited incomes, and can't afford professional advice.
Your Options If You Get a 1099-C For An Old Debt
My husband had a car repo in 2002 from Toyota. Last year (7 to 8 years later) we got a 1099 from Toyota saying they settled out debt for $3498.00. It was a weird looking letter and statement so I thought it was a sales gimmick and disregarded it. Now I have a letter from the IRS saying we own $480.00 from this debt cancellation. Can this be done? —Laura The consensus amount tax professionals I spoke with for this story seems to be that the taxpayer who receives one of these forms should first try to find out if he or she can avoid paying taxes on cancellation of debt income (CODI) by qualifying for an exclusion or exception, such as the exclusions for debts discharged in bankruptcy or due to insolvency. I discussed these in more detail in my first article, 1099-C In the Mail? How to Avoid Taxes on Cancelled Debt. If you qualify to exclude that income from your taxable income for the year, you may find it easiest to file Form 982 with your tax return and be done with it. [Related Article: More Confusion Over the 1099-C]
But what about someone who receives a 1099-C for a debt that is years—or decades—old? While they may have been insolvent by IRS standards at the time the debt was forgiven, their financial situation may be much different now, and income reported on a 1099-C could mean a big tax bill. Do they have any options?
When I asked Rob Deines and Tony Palizzi, tax associates with ProVision PLC, about a taxpayer who received a 1099-C for a debt that was written off two decades ago, their view was that the creditor was wrong in sending it so late. "They don't get to choose when they send the 1099-C," says Deines. "If they haven't tried to collect that debt in 10 or 20 years, then they are severely delinquent (in filing Form 1099-C)."
While you can dispute the 1099-C with the creditor that issued it, don't be surprised if they don't fix it. "You probably won't be successful in getting a corrected 1099-C," says Phillip P. Guttilla, shareholder with Polsinelli Shughart PC. "You'd have to dispute the 1099 (with the IRS). "
He adds: In tax audits, the IRS and taxpayer will often disagree over when cancellation of a debt occurred. The taxpayer may argue that cancellation of a debt occurred in a year on which the statute of limitations for assessment of additional tax has run and the IRS will take the position that the debt was discharged in a year that is still open to audit. A taxpayer recently won a case with the IRS over the timing of the discharge of debt.
It appears the IRS expects that taxpayers may have questions or disputes with the creditors about these forms. In the instructions, it states: "The creditor's phone number must be provided in the creditor's information box. It should be a central number for all canceled debts at which a person may be reached who will insure the debtor is connected with the correct department." (It's too bad the IRS doesn't publish a dedicated IRS phone number for taxpayers who have questions about this issue!)
A Loophole Perhaps? If You're Brave Enough If a taxpayer claims a 1099-C should have been issued years before, will the taxpayer then be required to file an amended tax return for the year in which the 1099-C should have been issued? Not necessarily, says Deines. The statute of limitations for the IRS to assess the tax generally expires 3 years after you filed your return. However, there is no statute of limitations for assessing and collecting tax if no return has been filed.
Dienes and Palizzi warned that there is no guarantee this approach—claiming that you don't have to pay taxes on COD income that should have been reported years ago—will work. It is certainly advisable to work with a tax professional.
Whether taxpayers who have already struggled with paying their debts will want to wrangle with the IRS on this issue remains to be seen. "No one really knows how aggressive the IRS is going to be," warns Gutilla. "Get good advice and make sure you follow the rules. If you get caught, you may end up paying taxes and penalties."