The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By David I. Kempler, Esq., and Elizabeth Carrott
Buchanan Ingersoll & Rooney PC, Washington, DC
In In re Reed, 492 B.R. 261 (Bankr. E.D. Tenn. 2013),
the Bankruptcy Court of the Eastern District of Tennessee held that
a Form 1099-C reflected that the issuing bank had discharged the
indebtedness, which taxpayers then reported as taxable income and,
therefore, were no longer indebted to the bank for that amount. In
reaching its decision, the bankruptcy court concluded that the
IRS's interpretation that the filing of a Form 1099-C does not
prohibit further collection of a debt was unreasonable and not
entitled to deference when the debtor, acting in reliance on Form
1099-C, included the discharged debt in gross income.
Under §6050P, an "applicable financial entity," such as a bank,
domestic loan association or credit union, must issue an
information return on Form 1099-C if it discharges $600 or more of
indebtedness. Under Regs. §1.6050P-1(b)(1), indebtedness is deemed
discharged solely for purposes of the §6050P reporting obligation
only upon the occurrence of any one of eight identifiable events,
regardless of whether an actual discharge has occurred on or before
the date on which the identifiable event has occurred.
In 2008, Husband and Wife signed a $304,000 promissory note in
favor of Bank secured by real property located in Tennessee. In May
2010, Bank foreclosed on the property. At the time of foreclosure,
the property had a market value of $262,500 and the amount
outstanding on the loan was $267,574. Bank filed with the IRS and
sent to Husband and Wife a Form 1099-C showing $5,074, the excess
of the amount owed over then market value, as having been cancelled
about 30 days after the foreclosure. Husband and Wife included that
amount on the "other income" line of their Form 1040 for 2010.
In April 2011, Bank sued Husband and Wife, seeking to collect
the $5,074, plus interest due after the foreclosure, related
attorneys' fees and other collection costs. In January 2012,
Husband and Wife filed for bankruptcy. Bank filed a proof of claim
in the bankruptcy proceedings for $18,825, which included the
$5,074, plus interest due after the foreclosure, related attorneys'
fees and other collection costs that had continued to accumulate.
Husband and Wife objected to the claim on the grounds that Form
1099-C filed by Bank constituted an admission by Bank that the debt
was cancelled or discharged and thus Bank was estopped from
enforcing its debt against them. Conversely, Bank, relying on
two IRS information letters previously issued - IRS Info. Ltr.
2005-0207 and IRS Info Ltr. 2005-0208 - and several cases decided
in reliance on those information letters,1 argued that a
Form 1099-C does not necessarily signal that a debt has in fact
The court, however, concluded that the IRS information letters
were not determinative because the language of the regulation
itself is open to interpretation. The court noted that an agency's
statutory interpretation is only entitled to deference when "a
statute is ambiguous, and if the implementing agency's construction
is reasonable,"2 and that
interpretations such as those in which lack the force of law,
information letters, are only "entitled to respect" to the extent
that the interpretations have the "power to persuade."3 The court stated
that here it was not persuaded by the two information letters
relied upon by other courts.
The court noted that it is well settled that gross income
includes income from the discharge of indebtedness under
§61(a)(12). The general theory behind this provision is that
to the extent that a taxpayer has been released from indebtedness,
he has realized an accession to income because the cancellation
effects a freeing of assets previously offset by the liability
arising from such indebtedness.4 The court
concluded that it would be "inequitable to require a debtor to
claim cancellation of debt income as a component of his or her
gross income and subsequently pay taxes on it while still allowing
the creditor, who has reported to the Internal Revenue Service and
the debtor that the indebtedness was cancelled or discharged, to
then collect it from the debtor."
The court ultimately concluded that, even though the issuance of
a Form 1099-C does not "as a matter of law" extinguish a debt, the
issuance of a Form 1099-C reflects the fact that a financial
institution has discharged that debt. Accordingly, the court held
that upon the issuance of the Form 1099-C by Bank, Husband and Wife
no longer owed the $5,074 or any interest, collection costs or
attorneys' fees associated therewith which were incurred after the
date of the Form 1099-C. The court, however, concluded any
interest, collection costs or attorneys' fees due and owing to Bank
on the date of the Form 1099-C but not collected prior to the
cancellation or discharge of the underlying indebtedness would
still be due and owing to the creditor. The court acknowledged that
it had adopted a minority view with respect to the effect of an
issuance of Form 1099-C, but stated that it believed it was the
proper view "in the interests of justice and equity.
In light of this decision, financial institutions should take
extra care to evaluate each situation to determine whether the
issuance of a Form 1099-C is appropriate, and, if one is issued,
whether a decision to take further action to collect on a debt can
be reconciled with the Form 1099-C as issued, or the Form 1099-C
previously filed needs to be amended or withdrawn. Moreover,
borrowers who receive a Form 1099-C should take care to properly
reflect the cancellation of indebtedness income on their tax
returns to increase protections against future collection
For more information, in the Tax Management Portfolios, see
Tatlock, 540 T.M., Discharge of Indebtedness, Bankruptcy and
Insolvency, and in Tax Practice Series, see ¶1040,
Discharge of Indebtedness.
1 . Accord Carrington Mortg. Servs., Inc. v.
Riley, 478 B.R. 736, 744 (Bankr. D.S.C. 2012) (stating that
the debtors' credit report and Form 1099-C received from the lender
were "not dispositive, and there is no evidence that the note has
been satisfied."); In re Sarno, 463 B.R. 163, 168 (Bankr.
D. Mass. 2011) ("It is apparent … that a form 1099-C is
"informational" and that it must be filed "whether or not an actual
discharge of indebtedness has occurred.").
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