Form 1099-C and COD Income: Key Timing Issues

A tax adviser faces a challenge when advising a client about the taxability of a canceled debt. In addition to breaking the news that the transaction is possibly a taxable event under Sec. 61(a)(12), the adviser may also need to assist the client in determining when to include the debt forgiveness in income. Sec. 108 outlines certain circumstances where a taxpayer may exclude debt forgiveness from taxable income; addressing that section is beyond the scope of this article, however. Lenders are required to issue Form 1099-C, Cancellation of Debt, to borrowers for whom debt has been discharged or forgiven. However, taxpayers should be aware that a lender's obligation to issue Form 1099-C may not coincide with the actual forgiveness. Occasionally, Form 1099-C is issued long after the actual cancellation of debt occurs as a lender attempts to "clean up" its records. Sometimes, conversely, the forms are issued before forgiveness occurs. Discussing potential debt forgiveness timing issues with clients is important in case a recognition event occurs without the corresponding issuance of a Form 1099-C. Regs. Sec. 1.6050P-1 provides Form 1099-C reporting guidance to lenders and specifies that reportable debt cancellation is triggered at the occurrence of an "identifiable event" indicating the debt may not be repaid. The identifiable event triggers a lender's obligation to issue Form 1099-C even though debt collection activity may later resume. Regs. Sec. 1.6050P-1 specifically states that identifiable events are outlined for Form 1099-C reporting purposes only and do not necessarily indicate a taxpayer should include debt forgiveness in income in the year that one of the identifiable events occurs. Determining whether debt forgiveness is includible in income in a situation is based on the situation's facts and circumstances. That said, the list of triggering events may be useful to the taxpayer in determining if debt forgiveness is includible in income.  The current regulations list eight circumstances under which an identifiable event is deemed to have taken place. One of the circumstances is the expiration of a 36-month period during which there has been no payment or collection activity on the debt. However, proposed regulations issued in October 2014 would remove the 36-month testing period from the fist of identifiable events. Although Regs. Sec. 1.6050P-1 is provided only for lender reporting purposes, several taxpayers have successfully relied on the 36-month test in court to dispute the IRS's ability to collect taxes on cancellation-of-debt (COD) income in a particular tax year (recently, Clark, T.C. Memo. 2015-175). Presumably, if the proposed regulations become final, neither taxpayers nor lenders will be able to invoke a preset period of collection inactivity as evidence of debt cancellation. If and when this change is made final (which had not yet occurred as of mid-January), taxpayers will no longer be put in a defensive position with the IRS simply due to a lender's obligation to issue Form 1099-C based on the passage of time--a positive aspect of the change. Clients needing to determine the point at which forgiveness is correctly includible in income may look to the other seven identifiable events fisted in the regulations but with cautious understanding that the regulations are provided only for Form 1099-C reporting obligations and may not accurately signify the moment at which a debt is forgiven or canceled. The other identifiable events listed in the regulations relate (in general terms) to: 1. Bankruptcy; 2. Receivership, foreclosure, or other court proceedings; 3. Expired statute of limitation; 4. Creditor foreclosure remedy elections; 5. Probate proceedings; 6. Debt discharge agreement between the creditor and debtor; or 7. Lender's decision or implementation of a policy to cease collection. …

Field of study: Business