Tax Help: How to Dispute A 1099-C Form

In 2006, “Anne” and her husband negotiated a settlement on credit card debt of $7,500 with one of the country’s biggest banks for roughly $2,900, wiping out just over $4,500 in debt. But just recently, the couple received a 1099-C from the credit card issuer reporting $16,000 in cancelled debt for the 2011 tax year. Both the amount and the dates are wrong, contends Anne (which is not her real name). Even though she has a copy of the settlement letter from the bank spelling out the terms of their agreement six years ago, a bank representative refuses to correct the 1099-C, stating that her husband had a separate credit card debt that triggered the form. Anne says that’s not true. “What can I do,” she asks?

Her story raises and important issue: what are taxpayer’s rights when lenders send 1099-C forms that are in dispute?

Start by trying to get the company that issued the 1099-c to correct it, advises Scott Tufts, a board certified tax lawyer with the Tufts Law Firm in Maitland, Florida. “The smartest move is to go to the source, even through the bureaucracy of the company. Document your reason for disagreement with the form,” he advises.

But as Anne’s story illustrates, getting through bank bureaucracy doesn’t always work. She said that after the bank representative refused to help, she told him she would be hiring an attorney to help her. “He ‘transferred’ me to another department, and the phone disconnected!” she told us in an email.

“What the IRS tells you to do is to call the bank to get it corrected but if you’ve ever talked to the bank, you know how far that’s going to go,” says Edward Zollars, a CPA and partner with the tax practice of Thomas, Zollars and Lynch in Arizona. “It’s kind of a mess,” he warns.

Cancelled Debt Isn’t Always Cancelled

I’ve written a series of articles about 1099-Cs and 1099-As, but to recap, these forms are used by lenders report cancellation of debt (COD) income to the IRS. The IRS generally considers cancelled debt to be income and it’s up to taxpayers who receive these forms to either include that amount in their income when filling out their tax returns, or demonstrate to the IRS why the amount should be partially or completely excluded.

The term “cancelled debt” in itself may be misleading. While these forms are sent to consumers who have negotiated settlements on debts for less than the full balance, or who have negotiated short sales on their homes, the IRS also requires that lenders notify them when there has been no significant collection activity on a debt for 36 months. The creditor may still decide to try to collect the debt at a later date, even though a 1099-C has been sent.

Problems arise when the amount reported on one of these forms is disputed. IRS instructions for Form 982, and Publication 4681 which details instructions for filling out that form, make no mention of what taxpayers should do if they believe the 1099-C they received is inaccurate.

The problem, explains Zollars, is that “the IRS locks onto the 1099 and they get blinders on, and assume it’s correct.” But he also insists that if taxpayers “cooperate with the IRS and they raise a legitimate doubt about a 1099-C, explain the situation and provide some documentation, then the burden shifts over to the IRS.” Zollars points to several Tax Court cases where taxpayers have prevailed in COD income disputes.

Both Tufts and Zollars advise taxpayers to include the amount of the 1099-C on their returns, even if they think it is wrong. Otherwise, the automated programs that the IRS uses to match information on returns to information received from lenders and employers may pick up the discrepancy and signal a problem to the IRS. “Report (the amount on the form) and then attach an explanation and back it off,” suggests Zollars.

In Anne’s case, she has written proof that creditor agreed to settle the debt in 2006. The 1099-C should have been sent for that tax year. The fact that the lender did not send one until the 2011 was not her doing. Because three years has passed since that tax return was filed, she should not have to amend her tax return from 2006 to include that income. Proving that to the IRS may be difficult, though, and will likely require Anne and her husband to hire a tax professional to help them.

What about taxpayers who defaulted on debts and never reached a settlement with creditors? It can be difficult to establish when the debt was cancelled or forgiven. In those cases, the IRS says creditors must send 1099-Cs after as many as three years of no collection activity. But it’s hard for a taxpayer to prove what happened in those intervening years.

Zollars teaches continuing education classes for tax professionals, and says these forms are creating complicated problems for tax professionals as they try to sort things out for their clients. He noted that his classes on this topic normally attract 30-35 attendees, “but this year we had 150 and had to reschedule another 110.”

Complaining May Get You Nowhere

Can you report a creditor who sends a flawed 1099-C and refuses to correct it with the IRS? You can try, but “the IRS probably doesn’t care much,” Zollars says. He suggests taxpayers instead complain to their elected officials in Washington.

Tufts, on the other hand, maintains that taxpayers may be able to take action against a company that issues an incorrect 1099-C and refuses to correct it. He says that’s especially true if there appears to be fraudulent intent.

The biggest lesson in all of this? Keep documentation of any settlements with creditors, short sales, foreclosures, or even defaulted debts for as long as possible. You never know when they may come back to haunt you. And if they do, get help from a tax professional.

Confused about how to deal with a 1099-C? Read: 1099-C In the Mail? How to Avoid Taxes on Cancelled Debt