TO 1099 OR NOT TO 1099

By Michael King posted 07-12-2018 19:18

  

QUESTION:    CAN WE STILL COLLECT THE DEBT AFTER WE FILE A CANCELLATION OF DEBT NOTICE WITH THE INTERNAL REVENUE SERVICE?

ANSWER:         YOU NEED TO CAREFULLY COMMUNICATE TO THE DEBTOR THAT YOU INTEND TO COLLECT THE DEBT EVEN THOUGH YOU FILED FORM 1099-C WITH THE IRS.

Can I “1099” the bum to make him pay?

Creditors sometimes threaten to file 1099 forms if debtors don’t pay. What they mean is that they will file Form 1099-C with the Internal Revenue Service (“IRS”) indicating that the debtors should pay income tax on the unpaid indebtedness. Threatening to turn someone into the IRS in order to make them pay your debt could be viewed as extortion, however. The creditor either has justification for the IRS filing, or it does not.   “Threatening” is not one of the reasons recognized by the IRS to require a filing.

You also need to be cautious in your Form 1099-C filings with the IRS not to create any defenses for your debtors. Careless 1099 filings may be construed as intentional discharges of indebtedness, letting the debtors avoid repayments.

How could we lose the right to collect a debt?

In 1989, Thomas Nicolas and his wife, Ellen Brown mortgaged a house in Connecticut. They borrowed $206,000 against the house. Franklin Credit Mgmt. Corp. v. Nicholas, 812 A.2d 51(Conn. App. 2002).

In 1991, Mr. Nicolas and Ms. Brown defaulted on the payments and eventually got divorced.   In 1994, Ms. Brown filed for bankruptcy. By then, the savings and loan from which they borrowed the money had failed and been taken over by the Resolution Trust Corporation (“RTC”).

The RTC issued an IRS Form 1099-C to Brown and Nicholas in 1995. Mr. Nicholas “reported the cancellation of the debt, as indicated on the form 1099-C in his 1995 income tax returns and incurred tax consequences.”

Franklin Credit Management Corporation (“Franklin Credit”) bought the note from the RTC and in 1998 began a mortgage foreclosure against Mr. Nicholas. Mr. Nicholas defended saying “the debt had been discharged and released pursuant to form 1099-C.”

The Connecticut court stated: “The form is used in the ordinary course of business to inform debtors of a cancellation of debt. Form 1099-C, therefore was prima facie evidence that the debt had been discharged.”

Franklin Credit did not show that the 1099-C was filed by mistake. Because the 1099-C proved that Mr. Nicholas’s debt was discharged, “Franklin Credit was forbidden to foreclose on the premises.”   After all: “The mortgage cannot survive the extinction of the debt.”

Careful with that IRS Form 1099-C!

“A small minority of courts in other jurisdictions have held that the filing of an IRS Form 1099-C alone is prima facie evidence of a discharge, which then requires the creditor to prove the form was filed by mistake or pursuant to other IRS requirements.” Flathead Bank of Bigfork v. Masonry by Muller, Inc., 383 P.3d 215 (Mont., 2016). Among the jurisdictions that recognize the filing of Cancellation of Debt notices with the IRS as prima facie evidence of debt forgiveness are Arizona and Connecticut. AmTrust Bank v. Fossett, 224 P.3d 935 (Ariz. Ct.App. 2009); Franklin Credit Mgmt. Corp. v. Nicholas, 812 A.2d 51(2002).

What is a Form 1099-C?

The Form 1099-C is commonly called a “Cancellation of Debt.” Internal Revenue Code 26 U.S.C. § 6050P requires the filing of the Form 1099-C when one of eight “identifiable events” triggers the reporting obligation by the creditor. The identifiable events include the filing of bankruptcy by the debtor, the expiration of the statute of limitations, the conclusion by the creditor that the debt is uncollectable, or the creditor’s decision “to discontinue collection activity.” I.R.C. § 1.6070P-1(b)(2)(i). Form 1099-C basically tells the IRS that the creditor doesn’t think that it can collect the debt. Sometimes the IRS will tax the gain received by the debtor when it fails to repay the loan.

How do you keep debtors from raising Form 1099-C filings as defenses?

In Arizona “issuance of a Form 1099-C may be prima facie evidence of cancellation of a debt, [but] the lender may rebut that evidence by showing that when it issued the form it did not intend to forgive the obligation.” AmTrust Bank v. Fossett, 224 P.3d 935 (Ariz. App. 2009). Even in Connecticut and Arizona, lenders can avoid the defense by sending notices to borrowers that they intend “to continue debt collection activities.”

Such notices to borrowers are prudent even in the majority of jurisdictions that do not recognize 1099-C forms as prima facie evidence of the intent to discharge debts.   As the Flathead Bank case says, the 1099-C “does not, in and of itself, prevent a creditor from seeking collection of a debt.” Thus, even in Montana, the form is some evidence regarding whether the debt has been forgiven.

Let me know if you have questions about overcoming creative defenses raised by your debtors.

Michael R. King

mking@gblaw.com

602-256-4405

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