|
Does Issuance of Form 1099-C Dissolve Debt? Bankruptcy Court Parts Ways with Other Courts.
(Parker's Federal Tax Bulletin: May 23, 2013)
A married couple defaulted on a loan secured by real estate. The bank that sold the property and had held the mortgage issued the couple a Form 1099-C, Cancellation of Debt, for the difference between what was owed and what the property was sold for. The couple included the amount in income and was surprised when, several years later, the bank tried to recoup the money the couple had reported as income, based on the Form 1099-C issued by the bank. In going after the couple, the bank was relying on previous court decisions that said the Form 1099-C did not necessarily discharge the debt. Luckily for the taxpayers, a bankruptcy court, in In re Reed, 2013 PTC 105 (Bankr. E.D. Tenn. 5/14/13), rejected the prior court decisions and held that the IRS's interpretation that the filing of a Form 1099-C does not prohibit further collection of a debt was unreasonable and not entitled to deference when the debtor has relied on the Form 1099-C and included the discharged or cancelled debt in gross income.
Background
In 2008, William and Debbie Reed executed a promissory note for $304,000 in favor of First Tennessee Bank (First Tennessee). The note was secured by real property. In 2010, the Reeds defaulted on the note and First Tennessee foreclosed its lien and sold the property. At that time, as reflected on the Form 1099-A issued by First Tennessee to the IRS, the difference between the value of the property and the outstanding principal balance of the Reeds' loan was $5,074. First Tennessee also filed with the IRS, and sent to the Reeds, a Form 1099-C, which stated that the $5,074 was cancelled in 2010. Based on the Form 1099-C, the Reeds included the $5,074 as other income on their 2010 Form 1040 as cancelled-debt income.
In 2011, First Tennessee Bank filed a lawsuit against the Reeds seeking to recover $12,075, representing the $5,074 principal balance and interest due under the promissory note after foreclosure, plus attorneys' fees and collection costs. Upon the Reeds' failure to respond, First Tennessee Bank filed a Motion for Default Judgment, at which time the principal and interest had increased to $12,307 and attorneys' fees and collection costs totaled $6,729.
On January 5, 2012, the Reeds filed for Chapter 13 bankruptcy case and First Tennessee dropped the Motion for Default Judgment. The bank then filed a Proof of Claim in the Reeds' bankruptcy case for $18,824, representing principal and interest in the amount of $11,773, attorneys' fees and collection costs in the amount of $6,729, accrued interest in the amount of $323, and interest as it continued to accrue from January 6, 2012, at a rate of $0.94 per diem, in accordance with the promissory note. The Reeds objected to the bank's claim and, in November 2012, the court scheduled a hearing.
The dispute was based solely on whether the Form 1099-C provided to the IRS, which required the Reeds to list the $5,074 of cancelled-debt income as part of gross income on their tax return, constituted a cancellation or discharge of the deficiency balance such that the Reeds no longer owed any obligation to First Tennessee under the promissory note.
Interaction of Code Sec. 6050P and Form 1099-C
The bankruptcy court began its analysis by reviewing Code Sec. 6050P and Reg. Sec. 1.6050P-1, provisions that provide the rules for preparing returns reporting the cancellation of indebtedness. The court observed that a Form 1099-C allows the IRS to compare the amount of the discharged debt claimed by a lending institution with the amount of income reported by the person whose debt was discharged.
A number of courts, the bankruptcy court noted, have held that the issuance of a Form 1099-C does not, alone, operate to extinguish a debt. For that proposition the court cited Atchison v. Hiway Federal Credit Union, 2013 PTC 106 (D. Minn. 2013); FDIC v. Cashion, 2012 PTC 315 (W.D. N.C. 2012); and Carrington Mortgage Services, Inc. v. Riley, 2012 PTC 316 (Bankr. S.C. 2012). Indeed, the bankruptcy court noted that a Massachusetts bankruptcy court, in In re Sarno, 2011 PTC 125 (Bankr. Mass. 2011), concluded that a Form 1099-C is informational and that it must be filed whether or not an actual discharge of indebtedness has occurred.
The bankruptcy court also cited IRS Information Letter 2005-0207, noting that several courts have relied on that letter to find that the IRS itself does not view a Form 1099-C as an admission that the creditor has discharged the debt and can no longer pursue collection thereon. The court cited the decision in Capital One, N.A. v. Massey, 2011 PTC 126 (S.D. Tex. 2011), in which the court cited the IRS information letter when finding that a Form 1099-C is issued to comply with IRS reporting requirements, not to discharge a debt.
The information letter cited was addressed to a company in the business of purchasing debts in large pools at a significant discount in answer to its request for information concerning the reporting obligations under Code Sec. 6050P for an organization that purchases debt. With respect to the issue in the instant case, the bankruptcy court cited the following text from the IRS information letter:
To briefly address your concerns about whether courts may view the filing of a Form 1099-C as a written admission that the creditor discharged the debt, and that debtors would be less willing to pay after your organization files a Form 1099-C, you should note the following. 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) of the regulations 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 bankruptcy court noted that the IRS information letter was supplemented by another information letter, Information Letter 2005-0208, containing the following question and answer:
Q5. Does filing a Form 1099-C upon the occurrence of an identifiable event prohibit future collection activity on the amount reported?
A5. Section 1.6050P-1(a)(1) of the regulations provides that solely for purposes of the reporting requirements of section 6050P of the Code, a discharge of indebtedness is deemed to have occurred upon the occurrence of an identifiable event whether or not there is an actual discharge of indebtedness. Section 6050P and the regulations do not prohibit collection activity after a creditor reports by filing a Form 1099-C.
The bankruptcy court also noted that each information letter expressly stated that the letters were intended for informational purposes only and did not constitute a ruling.
Conclusion
Although the bankruptcy court said it generally agreed with the basic assessment that the IRS requires financial institutions to issue a Form 1099-C as a reporting requirement, it disagreed with the other courts that the IRS information letters cited by many courts were determinative as to the issue at hand, finding that the language of Reg. Sec. 1.6050P-1 itself was open to interpretation. On the one hand, the bankruptcy court said it recognized that the IRS's interpretation of the regulations may be entitled to deference. On the other hand, the court noted that an agency's interpretation of what Congress intended is entitled to deference only when a statute is ambiguous and the implementing agency's construction is reasonable, even if the agency's reading differs from what the court believes is the best statutory interpretation.
It could not be discounted, the bankruptcy court stated, that the IRS's interpretation relied on by First Tennessee and other courts, which was based entirely on statements within the cited information letters concerning how the IRS views a Form 1099-C, directly conflicts with the Internal Revenue Code and the fact that cancellation-of-indebtedness income is included within a debtor's gross income.
Cancellation of debt or COD, the court said, is a term that is interchangeable with the term discharge of indebtedness. For COD income to occur under Code Sec. 61(a)(12), the court noted, the taxpayer must have been discharged from a liability. According to the court, debt is considered discharged the moment it is clear that it will not be repaid, and determining when this moment occurs requires an assessment of the facts and circumstances surrounding the likelihood of repayment. Any identifiable event that fixes the loss with certainty may be taken into consideration.
The court concluded that the IRS's interpretation that the filing of a Form 1099-C does not prohibit further collection of an indebtedness against a debtor was unreasonable and not entitled to deference when a debtor has, as required by the Internal Revenue Code, relied on the Form 1099-C and included the discharged or cancelled debt in gross income for the purpose of determining the debtor's taxable income. According to the bankruptcy court, it is inequitable to require a debtor to claim cancellation-of-debt income as a component of his or her gross income and subsequently pay taxes on it while still allowing the creditor, who has reported to the IRS and the debtor that the indebtedness was cancelled or discharged, to then collect it from the debtor. Cancellation-of-debt income, the court said, is not required to be reported to the IRS unless one of the express identifiable events occurs. The court found that if a financial institution has filed a Form 1099-C with the IRS, cancellation or discharge of a debt has, in fact, occurred.
As a result, the bankruptcy court held that the $5,074 reflected on the Form 1099-C was discharged or cancelled, such that the Reeds were no longer indebted to First Tennessee for that amount. While noting that it was adopting the minority view, the court said that in the interests of justice and equity, it was the proper view.
However, the bankruptcy court also held that the other amounts owed to First Tennessee (i.e., the interest, collection costs, and attorney's fees), which were not required to be reported under Code Sec. 6050P, and had not been reported on Form 1099-C, were still due and owing.
Staff Editor Parker Tax Publishing
ARCHIVED ARTICLES
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
Parker's Tax Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com
We hope you find our professional tax research articles comprehensive and informative. Parker's Tax Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.
Try Our Easy, Powerful Search Engine
A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play
Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.
Dear Tax Professional,
My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.
Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.
To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.
Our product, the Parker's Tax Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.
Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!
Sincerely,
James Levey
Parker's Tax Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com
|
