In PLR 202319009,[1] a credit union sought a ruling from the IRS regarding their obligation to issue Forms 1099-C for account write-offs resulting from a settlement of a class action suit. The credit union argued that the write-offs did not qualify as identifiable events as specified in Reg. §1.6050P-1(b)(2).

According to IRC §6050P(a), applicable entities are required to file a return, in the form and manner prescribed by the Secretary, when they discharge (in whole or in part) the indebtedness of any person during a calendar year. The return should include the name, address, and TIN of each person whose indebtedness was discharged, along with the date and amount of the discharged indebtedness, and any other information as prescribed by the Secretary.

Reg. §1.6050P-1(b)(2) provides a list of identifiable events that trigger the requirement to issue a Form 1099-C. These events include:

Discharge of indebtedness under Title 11 of the United States Code (bankruptcy)
Cancellation or extinguishment of indebtedness rendered unenforceable in a receivership, foreclosure, or similar proceeding
Cancellation or extinguishment of indebtedness upon expiration of the statute of limitations for collection
Cancellation or extinguishment of indebtedness pursuant to an election of foreclosure remedies by the creditor
Cancellation or extinguishment of indebtedness rendering the debt unenforceable in probate or similar proceedings
Discharge of indebtedness pursuant to an agreement between the applicable entity and the debtor at less than full consideration
Discharge of indebtedness due to the creditor’s decision or defined policy to discontinue collection activity and discharge the debt

In this ruling, the taxpayer presented the following facts:

Entity is a credit union organized in State X. When certain debtors defaulted on loans, Entity sent presale notices to the debtors stating that the collateral for the loans was being repossessed. Two of these debtors filed a class-action lawsuit in State X circuit court. In the lawsuit, the debtors alleged that defects in the presale notices Entity sent violated State X Law for failing to clearly state whether a borrower would owe the deficiency balance. After the filing of an amended petition, the parties engaged in discovery. The debtors filed a motion for class certification on Date 1. After the motion was briefed and argued by the parties, the court certified the class on Date 2. Subsequently, the parties agreed to a settlement. The settlement agreement was executed Date 3. The joint motion for preliminary approval was entered that same day. After a fairness hearing, the court granted final approval of the settlement on Date 4.[2]

The ruling sought clarification on whether the credit union was required to issue Forms 1099-C for the account write-offs resulting from the settlement. The outcome of the ruling and its implications are discussed below.

Specifically, the credit union requested the following ruling:

This letter responds to your request, dated August 11, 2022, for a ruling that Entity has no reporting obligation under Section 6050P of the Internal Revenue Code for the write-off of certain account balances pursuant to a court’s order granting final approval of a class action settlement. Your letter contends that there should be no reporting obligation because the discharge was not the result of an “identifiable event” listed in Treasury Regulation 1.6050P-1(b)(2), but rather was required by the operation of state law.[3]

Instead of granting the requested ruling, the IRS determined that an identifiable event had occurred, necessitating the filing of Form 1099-C. The ruling specifically highlights the fact that the identifiable event falls within the scope of the agency’s regulations, effectively addressing the situation at hand.

The identifiable event of primary relevance here is found in section 1.6050P-1(b)(2)(F). When an applicable financial entity and a debtor agree to discharge indebtedness for less than full consideration, this constitutes an identifiable event, and the discharge must be reported. To establish consideration, there must be a performance or a return promised which has been bargained for by the parties. Restatement (Second) Contracts §71(1) (1981). In this case, Entity and the debtor class members agreed to the entry of a judgment, approved and supervised by the court, which incorporates the parties’ settlement agreement by which Entity agreed to write off debt balances as part of the overall settlement of the pending litigation. This is an identifiable event described in section 1.6050P-1(b)(2)(F).[4]

The credit union expressed its objection, emphasizing that the settlement represented a determination that the write-off was obligatory according to state law, rather than a mutual agreement between the involved parties to resolve a pre-existing debt that the credit union had a legitimate claim to collect:

Entity’s request for a ruling contends that the settlement agreement does not reflect a mere agreement of the parties, or any other identifiable event, but rather is a recognition that the write-off of the deficiency balances was required under state law.[5]

The credit union is viewing the settlement as simply acknowledging that, under the operation of state law operating as the plaintiffs in the class action suit alleged, the debts were non-recourse under state law. In cases where a debt is non-recourse, the creditor’s recourse is limited to seizing the associated property, thereby ensuring full satisfaction of the debt.

But the IRS points out the agreement was simply a settlement of the plaintiff’s claim that the credit union could not collect any deficiency on these debts:

While the application of State X Law regarding the sufficiency of the presale notices may have been a factor in the parties’ decision to settle the litigation, such considerations are typical of parties’ assessment of litigation hazards in arriving at a negotiated settlement. The Agreement states that “[Entity] disputes the claims but desires to settle the claims being asserted against it on the terms and conditions in this Agreement to avoid the burden, expense, and uncertainty of continuing litigation.” The fact that the terms of the settlement agreement were approved and incorporated into the court’s Preliminary Order and Final Order does not serve to convert the discharge of the debt from being entered into voluntarily to one forced by operation of state law.[6]

The IRS did not find the judge’s statement in the Final Order, which concluded that the presale notices were unenforceable, to be compelling or persuasive:

Entity also argues that there was no identifiable event because the court in its Final Order stated that the court had made an independent judicial investigation into the legal sufficiency of the presale notices and held that the presale notices are unenforceable. But Entity vigorously pursued the litigation, including contesting class certification, throughout the pendency of the case. It was only by entering into a settlement agreement with the class members that Entity gave up its disputed claims to deficiency amounts. It was as part of this settlement agreement that the parties agreed to seek a judicial determination into a matter that they had already resolved, a determination made not as a result of the adversarial litigation process, but by mutual request of the parties as part of the settlement agreement. The debt write-off is due to the settlement agreement, not the court’s subsequent order.[7]

The IRS did not accept the judge’s finding due to the absence of opposing arguments presented by both parties in this specific area. It was in the interests of both the plaintiffs and the credit union to seek a ruling that would support the notion that state law mandated the treatment in question, in the hopes that the IRS would recognize and accept this finding. For the credit union, such a ruling would alleviate the need to issue Forms 1099-C, resulting in saved costs. On the other hand, for the plaintiffs, establishing that the debts were effectively non-recourse would be used as evidence to argue against any negative tax consequences stemming from debt cancellation.

However, this does not automatically imply that debtors will be required to report cancellation of debt income unless they meet one of the exclusions outlined in IRC §108. The crucial factor here is that the issue of whether state law necessitated the treatment of the debt as non-recourse has not yet been definitively decided. If a debtor can demonstrate that state law rendered the debt non-recourse, they can successfully assert that there is no taxable discharge of indebtedness, irrespective of the issuance of Form 1099-C. However, it is essential for the taxpayer to effectively make this argument.

A more pertinent question arises as to why the credit union sought this ruling. It is highly likely that the credit union’s advisors believed that issuing the forms was necessary in the given circumstances, or at the very least, there was a reasonable possibility that the IRS would adopt the position that Forms 1099-C had to be issued. By obtaining a private letter ruling, the credit union can argue that they made efforts to avoid issuing the Forms 1099-C (something the recipients were likely to complain about), but the IRS indicated that the credit union had no choice in this particular case.

[1] PLR 202319009, May 12, 2023, https://www.taxnotes.com/research/federal/irs-private-rulings/letter-rulings-%26-technical-advice/credit-union-must-report-cancelled-debt-of-class-action-plaintiffs/7gp14 (retrieved May 13, 2023)

[2] PLR 202319009, May 12, 2023

[3] PLR 202319009, May 12, 2023

[4] PLR 202319009, May 12, 2023

[5] PLR 202319009, May 12, 2023

[6] PLR 202319009, May 12, 2023

[7] PLR 202319009, May 12, 2023