By: Jennifer M. Monty, Esq. and Thomas Kendall, Esq.
Tax season creates questions for creditors and consumers alike. When do losses need to be taxed? Why is a consumer taxed for forgiveness of debt? Can the parties agree to waive the reporting requirement? Questions surround the issue, and it’s only made more complicated by the various ways a consumer and creditor agree to dispose of property.
When a creditor forgives, cancels, or discharges a debt, the creditor will need to file a 1099-C. Any forgiveness, cancellation or discharge potentially represents taxable income to the debtor. IRS regulations require a creditor to submit Form 1099-C in order to document the cancellation of more than $600 in principal. This requirement applies to secured and unsecured creditors alike. However, secured creditors may also have an obligation to file Form 1099-A, when they accept a property or when a property is abandoned.
When a Form 1099-C Must Be Filed
The most common type of form a creditor fills out is usually the Form 1099-C. This form -C must be filed when an “identifiable event” occurs with respect to the debt secured property. The identifiable event is when the debt is forgiven. In the case of a secured loan, the identifiable event is the canceling of debt, whether or not the creditor has re-sold the property.
Cancellation of debt is defined as money that is borrowed from a commercial lender and then later forgiven or cancelled by the lender. This working definition from the IRS is different than the use of it from a bank regulator’s standpoint. Generally accepted accounting principles and federal bank regulations provide that a retail loan that is past-due for 180 days should be classified as a loss and charged off. However, for purposes of issuing a 1099-C, the form must be filed when the debt is forgiven or cancelled, which may be after 180 days.
Examples of an identifiable event is an agreement to settle or cancel the debt between the debtor and creditor, or an agreement not to attempt to collect any remaining outstanding amounts. Any “identifiable event” which fixes the loss with certainty may be taken into consideration, repayment of the loan need not become absolutely impossible before a debt is considered discharged. The identifiable event can occur even when the creditor still has some technical right to repayment.
Following foreclosure, an identifiable event occurs when the creditor is barred from collecting the deficiency balance under state law (for example when the statute of limitations expires); the debtor and creditor sign a cancellation agreement; or a discharge results from a decision or defined policy of the creditor to discontinue collection of the deficiency. If the creditor intends to pursue the deficiency balance, the creditor should instead file Form 1099-A, listing the foreclosure sale price as the fair market value. If there is no deficiency balance, or a deficiency of less than $600, no 1099-C should be filed.
In the context of a deed in lieu of foreclosure, the identifiable event is the creditor’s execution of the deed-in-lieu agreement or instrument which states that the creditor is canceling or satisfying the debt. However, not every deed-in-lieu transaction will require reporting with a 1099-C form. If property is abandoned, or accepted in partial or full payment of a debt without any cancellation of indebtedness, only the 1099-A form needs to be completed. When there is still another co-debtor liable for the debt, the 1099-C form does not need to be completed. Nor is a creditor required to file a 1099-C form when only interest – not principal – is cancelled, or upon release of a guarantor.
For purposes of compliance, 1099-C must be mailed to the debtor by January 31st and to the IRS by February 28th of the tax year in which the debt was discharged.
When a Form 1099-A Must Be Filed
A mortgage lender must file Form 1099-A for the year in which the lender either took an interest in secured property or had reason to know that the secured property was abandoned by the borrower. The creditor’s obligation to complete Form 1099-A is not contingent upon cancellation of debt. The Form must be filed if the creditor accepts the secured property in partial or full satisfaction, even when the property’s fair market value exceeds the amount of the debt. The Form must be filed after the secured property is sold at foreclosure sale.
Abandonment occurs when “objective facts and circumstances indicate that the borrower intended to and has permanently discarded the property from use.” However, there is an important exception. If a creditor knows of the abandonment, but intends to commence foreclosure within three months, reporting is only required when the creditor eventually acquires an interest in the property, when a third party purchases the property, or at the end of the three-month period if no sale has yet taken place.
However, Form 1099-A is not required if a Form 1099-C is filed for the same year.
Relation between the 1099-A and 1099-C Forms
If an identifiable event of cancellation occurs in the same year that the creditor takes an interest in the secured property or the property is abandoned, the creditor is only required to file Form 1099-C. Form 1099-A should be filed only if: the secured property is abandoned and foreclosure has not been commenced within three months; the creditor accepts the deed in full or partial satisfaction of the debt, and intends to collect the deficiency; or when the property is sold at foreclosure sale and the deficiency has not been canceled in the same year.
What is Fair Market Value?
Both Form 1099-A and -C require the creditor to provide the fair market value (FMV) of the secured property. The FMV is either the appraised value of the property or the purchase price paid at a foreclosure sale. However, if Form 1099-A and 1099-C are both filed in the same year, the fair market value of the property is indicated on the 1099-A form, and the corresponding section of the 1099-C form is left blank; an updated FMV need not be determined.
Can the Parties Agree to Waive Reporting Requirements?
A creditor should not agree to waive any reporting requirements with a consumer. The reporting requirements are federal requirements. Once a creditor reports, the consumer can challenge the report with the IRS. To be safe, when settling a matter, a creditor should include language indicating that it does not make any representation regarding any tax implications and that a consumer should review with an independent tax advisor or counsel.
Muddling through the various reporting requirements can be daunting. If any questions arise, please contact Weltman, Weinberg & Reis Co., LPA (WWR).
Ms. Jennifer M. Monty, Esq. or Mr. Thomas Kendall, Esq.. Jennifer practices in Litigation & Defense located in the Cleveland office of WWR. She can be reached at 216.685.1136 or email@example.com. Thomas practices in Consumer Collections located in the Cincinnati office of WWR. He can be reached at 513.723.6052 or firstname.lastname@example.org.