Mr. Dunnigan would discover, in the case of Dunnigan v. Commissioner, TC Memo 2015-190 that merely because your bank and an IRS employee told you there wouldn’t be tax due on a cancellation of debt, that doesn’t mean there actually won’t be tax due.

Mr. Dunnigan had taken out a $50,000 line of credit for his business in 2008.  In 2009 Mr. Dunnigan found he was unable to pay off the line of credit, so he negotiated an agreement with the bank where the bank would take $15,628 in full satisfaction of the debt in question. 

The timing of cancellation of debt and the simple reality that banks often issue 1099C’s in a year other than the one where the income event took place came back to haunt the IRS yet again in the case of Clark v. Commissioner, TC Memo 2015-175.  But it had the interesting twist of the Court determining that the mere referral of a debt to a collection agency by a bank did not, by itself, show there had been substantial efforts expended in various years to collect the debt.

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).

In the case of Johnston v. Commissioner, TC Memo 2015-91, the IRS argued that the taxpayer failed to report cancellation of debt income in 2007, leading to a tax liability.

The question of whether a debt has been cancelled for the purposes of federal tax law depends on the showing that a debt will never be repaid, taking into account any identifiable event that establishes this fact.  The Tax Court cited the case of Cozzi v. Commissioner, 88 T.C. 435 to support the above analysis.

The IRS issued a new Audit Technique Guide entitled Real Property Foreclosure and Cancellation of Debt Audit Technique Guide that is meant to provide guidance to agents who encounter issues involving foreclosures and/or cancellation of debt.  However, as is true of many other such guides, the guide also provides a reasonably useful primer on the tax treatment in this area and contains some hints about the National Office of the IRS’s thinking on certain issues that may not be clear.

Erroneous Forms 1099C continue to plague clients and they often come from sources that an adviser would think should know better.  In the case of Bacon v. Commissioner, TC Summary Opinion 2015-15 the offending issuer was, like in the case of Kleber v. Commissioner, TC Memo 2011-233, an agency of the United States government, though this time it was the Federal Emergency Management Agency (FEMA) rather than the U.S. Navy.