Disputing Form 1099-C Debt “Forgiveness”

A taxable event may occur where a creditor ceases collection activity thereby forfeiting the ability to enforce a given obligation. This may give rise to a tax deductible ‘write-off’ upon the issuance of a form 1099C by the creditor. The erstwhile debtor, upon receipt of this form, must report it as taxable ‘forgiveness’ of debt in an amount corresponding to the write-off, as reflected in the form. This is known as imputation of income.

However, if a putative creditor has engaged in deceptive sales practices, or other bases exist to challenge the validity of the obligation, it may forfeit any tax advantages involving the ability to write off a bad debt upon default.  In the consumer credit context, a bad actor soliciting business through false pretenses may be subject to the disputed debt doctrine, prohibiting a tax deduction notwithstanding the status of a non-performing obligation. Fraud-in-the-inducement, for example, would give rise to a defensible position in disputing an issued form 1099-C. Other contractual defenses available under the disputed debt doctrine include failure of consideration, accord and satisfaction, waiver, estoppel, impossibility, mistake, set-off, frustration of purpose, and the like. The same of course could apply in any context involving the existence of a debt write-off.

Under these circumstances, the taxpayer may invoke case authority in filing the appropriate IRS form(s) through a tax professional in order to challenge the validity of   Simply put, if a taxpayer reasonably disputes the validity of an obligation, he or she should contact a qualified tax attorney or other professional tax advisor to challenge the imputed income.

Theoretically, an unscrupulous taxpayer could evade much if not all federal income tax liability simply through distribution of 1099-C documentation to its patrons, regardless of economic reality. For this reason, the Courts have established the disputed debt doctrine. Zarin v. Commissioner 916 F.2nd 110,115 (3rd Cir 1990); Smith v. Commissioner 198 F.3d 515 (5th Ci r 1999); Preslar v. Commissioner 167 F.3d 1323 (10th Cir 1999).

Furthermore, even if the disputed debt doctrine does not apply, under the doctrine of set-off, the taxpayers’ relinquishment of the right to the consideration for the obligation, the value of which exceeds the amount of the discharged debt, the imputed income tax obligation may still be subject to challenge. The IRS rules governing foreclosure or repossession may apply. If the debt involved is a recourse debt, you may have taxable income to the extent that the amount exceeds the far market value of the property at the time of the event.

There exist other exceptions and exclusions to taxation for 1099-C income including bankruptcy, insolvency, qualifying student loans, qualified business real property indebtedness, and qualified principal residence indebtedness. If you believe that one or more of these apply in your case, you owe it to yourself to consult with a qualified professional.