The following is an article reprinted with permission from the upcoming Winter 2009 edition of The WWR Letter:
By: Matthew M. Young, Esquire
With the start of a new year, we are only months away from everybody’s favorite deadline—April 15th. While filing taxes are among the most dreaded activities, a basic understanding of the Tax Code and what must be reported is essential for any credit union. Credit unions, like any creditor, are required to file Form 1099-C when they cancel a member’s debt in excess of $600. Several events can be viewed as “canceling a debt;” but in this article, the focus will be on non-collection of a debt.
Form 1099-C must be filed regardless of whether the member is required to report the debt as income and must be applied to debtors whether they are individuals, corporations, partnerships, trusts, estates or companies. For purposes of this reporting requirement, the IRS defines a debt as any amount owed to your credit union including the principal, any accrued interest, fees, penalties, administrative costs and fines.
Form 1099-C should be filed the year in which the identifiable event occurs. No additional reporting is required when a second identifiable debt occurs on the same debt. The IRS defines an identifiable event as follows:
1) A discharge of indebtedness under Title 11 of the Bankruptcy Code for business or investment debt. (*Creditors do not need to report a debt discharged in bankruptcy unless the creditor knows that the debt was incurred for business or investment purposes from a review of information included in the creditor’s books and records.)
2) A cancellation of indebtedness that renders a debt unenforceable in a receivership, foreclosure, or similar court proceeding.
3) A cancellation of debt where the credit union’s claim has been determined by a court to be barred by the expiration of a statute of limitations for collection.
4) A cancellation or extinguishment of debt pursuant to an election to foreclose where such proceeding bars collection of any deficiency (only applicable in some states).
5) A cancellation of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding.
6) A discharge of indebtedness pursuant to an agreement between the credit union and the debtor discharging the indebtedness at less than full consideration.
7) A discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity.
8) The expiration of the non-payment testing period (defined as being 36 months plus any time the credit union was unable to collect on the debt due to a bankruptcy or other legal stay imposed by state or federal law).
The Tax Code presumes that if no payments have been received for 36 months, then a 1099-C should be filed. However, this presumption can be overcome if the credit union or its collection representative has actively pursued collection activity on the debt within the last 12 months.
In certain jurisdictions, filing a 1099-C can serve as a bar to an otherwise valid collection claim. Even if not barred, the 1099-C’s filing can complicate a straightforward collection claim, allowing the debtor-member to raise a defense to the claim. Thus, the 1099-C is a poor collection tool. Unlike a charge-off, because a debtor has tax consequences when a 1099-C is filed, courts tend to give such a defense more credibility in weighing whether to allow a creditor’s claim to go forward. As a result, credit unions should be proactively pursuing its delinquent accounts and requesting suits be filed timely. By doing so, a credit union will be able to limit the number of 1099-C’s it must file, and more importantly, increase the credit union’s prospect of collecting on its delinquent accounts.
Matthew M. Young is an Associate in the Credit Union department of the Brooklyn Heights operations center. He can be reached at (216) 739-5726 or email@example.com.