Using A Tax Charge-Off As A Contractual Defense In Litigation

Pursuant to the IRS form 1099-C, a creditor may receive tax benefits by discharging an obligation owed by one otherwise indebted.  IRS form 1099-C attached as Exhibit A.  These circumstances may compel a Court to find that the filing of an IRS form 1099-C establishes a discharge of the underlying obligation, where it has caused imputed income for the forgiveness of debt thus creating actual tax liability, and that as a result,  further collection efforts are barred.

While there remains no controlling authority in many jurisdictions as to the effect of filing a 1099-C, in Wright v. Deutsche Bank Nat’l Tr. Co., 245 So. 3d 786 (Fla. 4th DCA 2018), the Fourth District Court noted in dictum the split of authority:

An entity must file a Form 1099-C with the IRS when it discharges a person’s indebtedness. See 26 U.S.C. § 6050P(a); 26 C.F.R. § 1.6050P-1(a)(1). There is a split of federal authority on whether the form is sufficient evidence of a discharge of debt. See In re Rodriguez, 555 B.R. 871, 875 (Bankr. S.D. Fla. 2016). The majority of courts have noted that the IRS Code requires a creditor to file a Form 1099-C to comply with IRS reporting requirements, even if an actual discharge of debt has not yet occurred. . . ; see F.D.I.C. v. Cashion, 720 F.3d 169, 178-79 (4th Cir. 2013) (finding the IRS treats the form “as a means for satisfying a reporting obligation and not as an instrument effectuating a discharge of debt or preventing a creditor from seeking payment on a debt.”).

Wright v. Deutsche Bank Nat’l Tr. Co., 245 So. 3d 786 (Fla. 4th DCA 2018) (“However, appellee did not seek a deficiency, and appellants’ personal liability was not at issue. Thus, we need not decide whether the Form 1099-C created an issue of fact as to damages in this in rem   foreclosure action.”)

A number of courts have held that the filing of a Form 1099-C with the IRS constitutes prima facie evidence of an intent to discharge a loan, at which point the burden of persuasion shifts to the creditor:  See In re Welsh, No. 06-10831ELF, 2006 Bankr. LEXIS 3756, 2006 WL 3859233 (Bankr. E.D. Pa. Oct. 27, 2006) (unpublished); Amtrust Bank v. Fossett, 223 Ariz. 438 (Ariz. Ct. App. 2009);  Franklin Credit Mgmt. Corp. v. Nicholas, 73 Conn. App. 830, 812 (Conn. App.2002).

 In F.D.I.C. v. Cashion, 720 F.3d 169, 178-79 (4th Cir. 2013),   the court in held the act of filing a 1099-C alone was not determinative of whether the debt was discharged. The IRS did not create the form as a means of effectuating the discharge of a debt. It is, instead, a reporting mechanism to the IRS. Moreover, because a creditor can be required to file a Form 1099-C even where a debt has not been cancelled, the mere fact that a Form 1099-C is filed does not constitute sufficient evidence, standing alone, that a debt has been cancelled. Without more, it is impossible for a court to know what the existence of a filed Form 1099-C means. It may mean the debt has been discharged; it may mean the creditor intended to discharge the debt in the future; or it may mean that another of the “identifiable events” in the regulation occurred apart from an actual discharge. FDIC v. Cashion, 720 F.3d 169, 180 (4th Cir. 2013).

The court in Cashion equivocated, “While some of the circumstances triggering the obligation to file a Form 1099-C may bar collection, it is that separate circumstance and not the fact of filing a Form 1099-C that acts as the bar.”  Cashion, 720 F.3d at 179 n.7.  Cashion is distinguishable from cases involving a demonstrable economic reality where actual tax benefits and corresponding detriments occur.   ZB, N.A. v. Crapo, 394 P.3d 338, 340 (Utah 2017) (“The regulation defines ‘discharge’ in a way that includes more than actual discharges. . . .The regulation . . .provides eight different identifiable events. The first seven, codes A-G, correlate to events that necessarily involve an actual discharge of debt.”) (emphasis added).

In an instance where form  1099-C, on its face reflects the necessary circumstance demonstrating actual discharge, e.g.. wherein a creditor makes the decision “to discontinue collection activity and discharge [the] debt”  under 26 C.F.R. § 1.6050P-1(b)(2)(i)(G); (In such a case, the form 1099-C form would reflect event code “G” tracking the foregoing language, as the basis for the discharge); Baker v. Am. Fin. Servs., No. 3:16-CV-00065-GNS, 2016 U.S. Dist. LEXIS 97040, at *7 (W.D. Ky. July 25, 2016) (emphasis added) (“[A]n admission by the creditor within the Form 1099-C plausibly indicates discharge even if the mere filing of the form does not.”).

Notwithstanding the form itself or anything to be interpreted from it, if the debtor incurs actual tax liability, a discharge barring subsequent collection efforts may be found to occur.  In re Lukaszka, No. 17-00242, 2017 Bankr. LEXIS 2196, at *7 (Bankr. N.D. Iowa Aug. 4, 2017) ( In holding the debt was canceled, the court distinguished Cashion, because the debtor relied on evidence of the incumbent tax liability in addition to the 1099-C form); Newton v. Beneficial Fin. I, Inc., Civil Action No. 3:16CV00058, 2017 U.S. Dist. LEXIS 53341, at *9 (W.D. Va. Apr. 6, 2017) (quoting FDIC v. Cashion, 720 F.3d 169, 180 (4th Cir. 2013)) (“The Fourth Circuit was ‘careful to note the specific circumstances’ of the case before it and the ‘narrowness’ of its holding. . . . The Court observed that the case was ‘likely an oddity, where the 1099-C Form [was] the only evidence of debt discharge before the Court.’).

Consistent with the foregoing authority, the discharge of debt barring civil prosecution to enforce it must correspond to economic reality: The creditor has received an actual financial benefit arising from a tax deductible discharge of debt, whereas the debtor has a incurred a corresponding financial burden equating to the amount of the discharge – imputation of income for the forgiven indebtedness.

Under these circumstances, further collection must be barred, as it is inequitable to permit the Creditors to impose tax liability on this Debtor after Creditors benefited from a tax write off, while then allowing Creditors to enforce the now discharged obligation through the arbitration award. It is 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. In re Reed, 492 B.R. 261, 271-72 (Bankr. E.D. Tenn. 2013); Franklin Credit Mgmt. Corp. v. Nicholas, 73 Conn. App. 830, 847-848 (Conn. App. 2002); In re Lukaszka, No. 17-00242, 2017 Bankr. LEXIS 2196, at *9 (Bankr. N.D. Iowa Aug. 4, 2017); See In re Crosby, 261 B.R. 470, 474 ( In dictum the court stated: “The actual (or at least potential) tax consequences of the form [1099-C] make it inequitable to allow the [creditor] to enforce its claims against the debtors.”); See FDIC v. Cashion, 720 F.3d 169, 178 (4th Cir. 2013) (Discussing that, “[Some] courts have generally noted that because filing a Form 1099-C has legal significance to the debtor’s income tax liability. . . .it would be inequitable to permit a creditor to collect the debt after having received the benefit of the “charge-off” of the debt. . . .”).

Moreover, where a form 1099-c has been filed, invocation of the Uniform Commercial Code may warrant a finding that a writing constitutes an “intentional voluntary act” of discharge. See, e.g.,  Fla. Stat. § 673.6041.  Along these lines, the court in Cashion stated the following: Lastly, some—but not all—of the courts holding that a filed Form 1099-C alone is prima facie evidence of discharge have also recognized that the form can satisfy the applicable UCC provisions for when a writing constitutes an “intentional voluntary act” of discharge, and thus itself effectuates the discharge of the relevant debt. See, e.g., Franklin Credit Mgmt. Corp., 812 A.2d at 60-61. FDIC v. Cashion, 720 F.3d 169, 178 (4th Cir. 2013). As a result, the Creditors’ 1099-C form itself discharges the underlying obligation under Florida’s applicable UCC discharge statute, such as Fla. Stat. § 673.6041. This digest does not constitute formal tax advice and should not be relied upon without consulting a tax attorney.