One way New York bankruptcy benefits debtors over debt settlement or other non-bankruptcy options is that debtors do not need to pay income taxes on cancelled debts. Normally, cancelled debts are considered income, so when lenders forgive debts greater than or equal to $600, they are obligated to send debtors IRS Form 1099-C, which leads them through the process of estimating their income taxes for the forgiven amount. In the form’s “Box 6,” ominously titled, “Identifiable event code,” a creditor must include one of eight alphabetical letters explaining why it is generating the form.
There’s just one problem for debtors: Until recently, one of the codes didn’t apply to a situation in which a debt was forgiven at all.
Specifically, “H – Expiration of nonpayment testing period,” meant that if the debtor had not made any payments on the debt for a certain time period, the creditor (which could be a debt collector) had to send the form anyway. According to IRS Publication 4681, the testing period was 36 months (three years), so if a creditor had not received payment on the debt for the three years before the end of the tax year (excluding stays like bankruptcy), it could mail the debtor the form. The debtor would then pay income tax on a debt that had not been forgiven and was not income to the debtor.
Understandably, the code confused debtors because they suffered the tax liability of a cancelled debt without the advantage of its cancellation. Debtors did not know if they still owed the debt, and they did not understand if they had to report the debt as discharged per Form 1099-C because it had not been. The code did not contribute to debtors’ compliance with Form 1099-C’s requirements, and it did not provide the IRS with third-party information from creditors about debts because the debts had not been erased. For these reasons, in November 2016 the IRS remedied that by eliminating code H entirely. Now debtors will only receive Form 1099-C for debts that have in fact been forgiven.
The announcement in the Federal Register of the rule’s change is here (pdf), IRS Form 1099-C is here (pdf), and Publication 4681 is here (pdf). The latter two are now out of date, and the rule went into effect November 10, 2016.
The IRS’s change to the event code rules should reduce debtors’ confusion when receiving Form 1099-C for debts that their creditors did not cancel. If you owe substantial debts, bankruptcy can help clear most of them without any need to pay income tax.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced fair debt collection practices act Bruce Weiner for a free initial consultation.
