Uncollectible Debts: I 1099-C You – July 2017

Issue 44, July 2017

Just as you can’t get blood out of a turnip, some debts just aren’t collectible. What is a lender to do when left holding the bag? Often, the only option is to forgive the debt, charge it off the books, and take a deduction for the loss on your taxes. This “debt forgiveness” allows a creditor to file IRS form 1099-C, which not only gives a deduction to the creditor, it converts the unpaid debt into income for the debtor, for income tax purposes. A 1099-C can provide a measure of justice for a lender, and often comes as an unwelcome surprise to a debtor.

When to Issue a 1099-C

The trigger for filing a 1099-C is tied to an “identifiable event,” which makes it clear that the borrower has no intent to pay the debt, and the lender has no intent to collect. Those events are: (i) a discharge in bankruptcy; (ii) cancellation of the debt in connection with a court-supervised receivership; (iii) the expiration of the statute of limitations; (iv) the exercise of foreclosure remedies; (v) discharge in probate-related actions; (vi) an agreement with the debtor to discharge the debt for less than full consideration; and (vii) discontinuation of collections and discharge of the debt pursuant to a creditor’s defined policy. If any of these events occur, a creditor must file a 1099-C with the IRS for debts over $600.

Until recently, the identifiable events which triggered a 1099-C filing also included the “36-Month Rule.” Under the rule, if a debtor made no payments for 36 months, the law presumed the lender had no intention of pursuing the debt any further, and, barring evidence of any recent, bona fide efforts to collect the debt, the lender was required to issue a 1099-C whether the lender intended to continue collection efforts or not.

The 36-Month Rule was abused by some lenders and caused no small amount of confusion among debtors and lenders alike. For these reasons, the IRS abolished the rule in 2016. Creditors may no longer issue a 1099-C based solely on the passage of time, unless the creditor has an internal policy requiring forgiveness of the debt under that circumstance.

Discretionary Filings

While creditors are required to file 1099-Cs in the wake of the foregoing identifiable events, creditors may elect to file in the absence of an identifiable event. For example, if a creditor has a policy to abandon a debt after four years of inactivity, a creditor may choose to abandon the debt prior to that time if a debtor presents hardship circumstances but never quite makes it into bankruptcy and never enters into a formal debt-cancellation agreement. Also, a creditor is not required to file a 1099-C for a debt discharged in bankruptcy if the debt was not incurred for business or investment purposes. Likewise, 1099-Cs are not required when a lender releases a co-debtor, as long as the remaining debtors are liable for the full amount. Lenders may not issue 1099-Cs to guarantors, as they do not qualify as “debtors” for the purposes of the form.

Debt collection can be tricky. Should you find yourself in the position of having to collect or cancel a debt, we can help. Give us a call.