Form 1099-C

I came across a recent case (Gericke v Truist, No. 20-3053 (DC NJ 3/26/21)) that once again highlights the mismatch between the law on Form 1099-C, Cancellation of Debt, issuance and when a debt is actually discharged. 

The District Court of New Jersey issued a ruling that reminds us all (again) that getting a Form 1099-C doesn’t mean that the debt was discharged, it just means the lender met one of the seven requirements of the regulations under Section 6050P to issue a 1099-C. So, when a borrower receives a Form 1099-C it is not necessarily clear that the debt is discharged. If not discharged, there is no cancellation of debt income or ability to see if an exclusion under Section 108 applies, such as insolvency.

The Form 1099-C instructions for the borrower includes this confusing statement to illustrate the flaw with the form:

If an identifiable event has occurred but the debt has not actually been discharged, then include any discharged debt in your income in the year that it is actually discharged, unless an exception or exclusion applies to you in that year.”

Who wouldn’t understand that?!

This is a problem for the borrower (and their tax adviser) and the IRS. If the Form 1099-C is not reported because the borrower finds out that the lender is still going to continue to collect, the IRS is likely to send a notice of the unreported income.

I think the fix is both with Section 6050P and the Consumer Financial Protection Bureau or other federal agency that handles consumer credit law. But the key body to fix the law, of course, is Congress to change Section 6050P and credit card and consumer borrowing laws so that both define discharge the same and that no 1099-C is required until the debt is truly discharged with a specific form documenting that status. The rules should be synced that a 1099-C is only issued if the debt is truly cancelled. 

Benefits to the tax system of fixing this include not wasting IRS time to issue a notice for not reporting a 1099-C only to have the taxpayer say the debt has not been discharged yet (they have not been released from it). Benefits to borrowers are clarity of the law. The judge in this recent case even acknowledges that this law is beyond what a “common consumer” will understand and is a matter for Congress to fix.

SCA 200235030 (8/30/02) from the IRS also notes that receipt of a Form 1099-C doesn’t mean that the borrower has income to report. Instead there needs to be an identifiable event to indicate discharge.

Likely with tough times since March 2020, we will see more debt cancellation and it is important for all parties to be able to handle the tax treatment correction but that requires undertsandable and sensible rules that won’t lead to errors.

What do you think?