A reader has ignited quite a debate among the debt experts.
"Tricia" is trying to settle her debts. One of her creditors had sent her a 1099-C, which is the form used to notify the IRS that a debt has been canceled or forgiven. (See, the IRS considers a forgiven or canceled debt as "income" and wants a piece of the action. But that’s fodder for another post.)
Tricia had been told that the 1099-C didn’t mean the debt was truly canceled. The balance could still be turned over to a collection agency and she would have to then try to work out a settlement with the debt collector. It didn’t sound right to Tricia, so she started asking the experts, and that’s when things got interesting.
In one camp are the experts who agree with the opinion above. The creditor may have written off the debt, the say, but it can still be sold off to a collector and she would have to pay if the collection agency comes after her.
On the other side are those who believe the 1099-C is proof the debt was canceled. If she hears from a debt collector, they advise, she can fax them a copy of the 1099-C and they would have to leave her alone.
When Tricia contacted me for my opinion, I decided to to straight to the "top" and offered to ask the National Consumer Law Center. The NCLC is known as "America’s Consumer Law Experts." Their motto, which they live up to, is "Protecting Vulnerable Consumers and Promoting Marketplace Justice." Not only do they publish voluminous manuals on consumer protection laws (including the Fair Debt Collection Practices Act) but they also develop important consumer protection initiatives, such as a recent study of High-Fee Predatory Credit Cards.
Deanne Loonin, a highly respected attorney for the group, responded to my inquiry. After informing me that the question caused "quite a stir" at her office, Deanne said:
…the bottom line from what we found is that the issuance of IRS form 1099-C is evidence of the creditor’s cancellation of the debt justifying the denial of a proof of claim in bankruptcy or foreclosure. That evidence of cancellation may be rebutted by a corrected form 1099-C stating that the debt was not canceled.
I am not an attorney, so I wanted to make sure I understood her answer. I asked her:
So if I understand you correctly, the 1099-C indicates the debt has been canceled, but the creditor can later submit a corrected 1099-C and then resume collection activity?
Deanne replied:
Well, this was more of an evidentiary issue if it is raised in court. In that case, the 1099-C is evidence for the debtor that the debt has been canceled. The creditor could rebut the evidence by introducing a corrected version, but I don’t think that happens often. Whether they can resume collection depends on what the corrected version says. It could just be correcting the amount canceled.
It sound like Tricia should hold onto a copy of the 1099-C and provide it to any collector that later tries to collect the debt. If a debt collector is persistent, or tries to take her to court, she’ll need to talk with a consumer law attorney asap.
In the meantime, though, she’ll have to find out whether she must pay the IRS taxes on that forgiven debt.
Gerri Detweiler Credit.com's Personal Finance Expert, Gerri focuses on financial legislation, budgeting, debt recovery and consumer savings information. She is also the co-author of Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights, and Reduce Stress: Real-Life Solutions for Solving Your Credit Crisis as well as host of TalkCreditRadio.comTalk Credit Radio. Reach Gerri at creditexperts@credit.com.
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If a consumer is that far in the hole, it’s a good chance (s)he can get out of paying any taxes. If you are insolvent at the time a debt is ‘cancelled’, and you can satisfy the IRS of that, then no taxes are owed.
Insolvency generally means your debts are more than your assets, which is too true for a lot of Americans. You have to jump thru the IRS hoops, but it’s certainly worth doing the form if you’re in way over your head.