Saturday, March 15, 2008

Cancellation of Debt: Tax Consequences

We're getting into tax season, and it should be remembered that, in addition to the 1099's that are issued for persons paid money, certain creditors have an affirmative duty to issue a 1099-C for compromised indebtedness. This applies to any cancelled debt over $600. Multiple cancellations of a debt are not to be aggregated for purposes of determining whether the $600 is met, unless, of course, the reason that each debt is less than $600 is to avoid triggering the 1099-C filing requirement (you didn't think the IRS would let you get away with this glaring loop hole, did you?).

As a result, any financial institution or other organization "whose significant trade or business is the lending of money," such as a finance company, credit card company, and the like (whether or not affiliated with a financial institution) must file a 1099-C for cancelled debt. The degree of business necessary so as to be considered "significant" has been defined as when money is lent on a "regular and continuing basis."

Thus, for example, if you are in the finance business and a debt is negotiated from an original balance of $10,000 down to $4,000, then the creditor must issue a 1099-C for the portion that has been written down -- $6,000.

There are different rules for secured property (i.e. collateralized personal property or mortgaged real property) that is abandoned by the debtor in exchange for the cancellation (such as a "deed in lieu of foreclosure"). This filing requirement appears to be for everyone, not just financial institutions and those who are in the business of lending money. Thus, if you "acquire an interest in property that is security for the debt," (or if you merely have reason to know that the property has been abandoned) in full or partial satisfaction of such debt, then you need to file a 1099-A or merely fill out boxes 5 & 7 of the 1099-C. According to the IRS, the proper filing of the 1099-C will meet this requirement. This can be a nasty surprise for the debtor who gets one of these, but the rules are the rules!