A debt collection agency did not mislead debtors by failing to inform them that compromising a debt could have tax consequences according to the Second Circuit Court of Appeals in the case of Altman v. J.C. Christensen & Associates, Inc., 2015 TNT 94-13, CA2, No. 14-2240.  Thus there was no basis for the claim that the collector had violated the Fair Debt Collections Practices Act (FDCPA).

A taxpayer must recognize income from the cancellation of debt pursuant to §61(a)(12) in the year in which the cancellation takes place.  The taxpayer may be able to exclude some or all of the cancellation of debt from income under the various provisions of IRC §108 (most notably if cancellation is part of a bankruptcy case or to the extent the taxpayer was insolvent prior to cancellation), but if no relief provision applies the taxpayer faces taxes at ordinary income rates with no cash on hand to pay the tax.

This case involved letters issued by the collection agency in attempting to get a debtor to enter into an agreement to pay some or all of an outstanding debt.  The letter in question, as cited by the court, provided:

Your Bank of America/FIA Card Services N.A. account has been placed with us for collections. Our services have been contracted to represent in the recovery efforts of your delinquent account. Our records indicate that the outstanding balance on your account is $6,068.13.

In an effort to resolve this matter as quickly as possible we have been authorized to negotiate GENEROUS SETTLEMENT TERMS on this account. Please review the following settlement opportunities to make voluntary resolution of your account a reality:

1. Settle your account now for a lump-sum payment of $3,155.43. That is a savings of 48% on your outstanding account balance.

2. Extend your time and settle your account in three payments of $1,314.76. This is a savings of $2,123.85 on your outstanding account balance.

3. Further extend your time and pay your balance in full in 12 payments of $505.68.

The FDCPA bars the use of false, deceptive or misleading representations in connection with attempting to collect a debt.  The plaintiff in the case argued that the stated savings in the letter for a debtor choosing option 1 or 2 was misleading, as such savings would be reduced by any taxes that would be due on the cancellation of debt income.

The Second Circuit disagreed, find the statements in the letter only specified the percentage reduction in the outstanding balance.  The Court notes “[t]he fact that a debtor may then have to pay tax on the amount saved is simply not deceptive in the context of what the savings are on a debtor's ‘outstanding account balance.’”