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Taxpayers who get a 1099-C listing cancellation of debt income have enough to worry about. Their main concern: “Do I have to pay taxes on the reported amount?” They shouldn’t have to worry that a lender’s sloppy practices could also be setting them up for an audit. But that’s precisely what may happen when lenders send out 1099-C’s that are wrong and won’t correct them.

This isn’t a far-fetched scenario, unfortunately. There are a variety of problems taxpayers have raised in comments to my previous stories. They’ve told us they are getting 1099-C’s for:

  • Debts that were long ago discharged in bankruptcy, but the lender is claiming there is no record of the discharge.
  • Homes that were foreclosed, but the “fair market value” listed on the form is way off.
  • Very old debts that should have been reported as cancelled many years ago.
  • Debts that include inflated fees or other charges that cannot be accurately accounted for.

[Related Article: 1099-C: The Worst Tax Mess of the Year?]

What If the 1099-C Form You Receive Is Wrong?

Scott Estill, a former IRS Senior Trial Attorney tax attorney now with Estill and Long LLC, explained what may happen if a 1099-C is wrong:

If a lender issues a 1099-C that is wrong and refuses to correct it, I would advise the taxpayer to correct it himself or herself so that the return contains accurate information.  The problem thus occurs because the information the taxpayer reports does not match the 1099-C and thus the chances of an audit are great in this situation. As such, the taxpayer will need to attach supporting documentation to the tax return showing the discrepancies and what was done to resolve them and prepare an accurate return (if the return does not match the 1099 and the IRS wants to audit this- the supporting documentation may help explain what was done and avoid an audit).

Anytime a taxpayer needs to reconstruct records to make them accurate, they should keep good notes of who they talked with at the lender (names, dates, substance of conversation) for proof if audited.  The taxpayer may need to get an appraisal done (if the fair market value of real estate is disputed on the 1099-C) or obtain other documentation depending upon which part of the 1099-C was wrong. The documentation should let the IRS know of the nature of the discrepancy and what the taxpayer did to try to resolve it. Other than this and trying to get the lender to make the necessary corrections, there isn’t much a taxpayer can do to fix the situation! But if questioned by an IRS employee, the taxpayer can say that they did not file the 1099-C that was reported because it was inaccurate- and the IRS wouldn’t want us to file an incorrect return, would they?

Unfortunately some of the taxpayers who are getting these inaccurate forms no longer have documentation to back up their side of the story. Think about it. Would you be able to dig up documentation of a debt wiped out a decade ago? I’m a paperwork packrat, but I’d have trouble pulling out ten-year-old account information.

And don’t lenders have some responsibility here? Mike wrote to us about a 1099-C he received from his bank. The bank had waived overdraft fees incurred when he had a run-in with a payday lender. Even though the fees were questionable to begin with, and the bank agreed to waive them, the bank sent him a 1099-C, five years after the fact. He asks,

Can I 1099-c them back or sue them for it?

It’s a good question. But getting an answer may be costly.

Image: Warner Brothers

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