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Taxpayer's Debt Was Discharged Years Earlier than Form 1099-C Indicated.

(Parker Tax Publishing October 5, 2015)

A taxpayer was not liable for cancellation of debt income in 2011 where the IRS failed to provide any evidence of any significant, bona fide activity that would indicate an active creditor, and thus failed to rebut the presumption that an identifiable event discharging the taxpayer's debt occurred in 2008. Clark v. Comm'r, T.C. Memo. 2015-175.

Background

In December 1999, Patricia Clark entered into a retail installment contract with an automobile dealership to purchase a used 1996 vehicle for $13,547. Clark made a down payment of $1,000 and financed the remaining $12,547. The contract required 60 monthly payments over five years starting January 21, 2000.

The contract also provided that, if the dealership repossessed the vehicle, it could sell the vehicle and apply the proceeds received to what buyer owed. Further, if the dealership repossessed or accepted the voluntary surrender of the vehicle and the original price was $500 or more, and the balance remaining unpaid at the time of default was $300 or more, the buyer would be liable for any deficiency incurred as a result of the sale or disposition of the vehicle and the dealership would have the right to a deficiency judgment.

By 2005, Clark had defaulted on the contract and the vehicle was repossessed in March of that year and sold for $1,300 at an auction in June. The proceeds from the auction were applied to her account in June. However, Clark still owed almost $4,800 on the contract and $740 for collection expenses and late fees. The dealership sent Clark a letter in June 2005, notifying her of the remaining amount owed and requesting that she make contact about payment before the dealership resorted to debt recovery. The dealership assigned Clark's debt to five separate third-party debt collectors. It subsequently wrote off the debt, determined Clark's charge off balance to be approximately $4,600, and reported on Form 1099-C, Cancellation of Debt, that Clark had COD income that was discharged in August 2011. The Form 1099-C indicated that Clark was personally liable for the repayment of the debt.

Clark disputed the cancellation of debt (COD) income. Based upon her understanding of the instructions for Form 1099-C, Clark argued that the debt should not have been deemed canceled in 2011 with the filing of Form 1099-C. Instead, she asserted, the cancellation actually occurred when the dealership failed to receive payment on the debt over a 36-month period that ended December 2008.

Analysis

The Tax Court held that Clark did not have COD income in 2011. The court cited its decision in Cozzi v. Comm'r, 88 T.C. 435 (1987), in which it concluded that (1) the moment it becomes clear that a debt will never have to be paid, the debt must be viewed as having been discharged, and (2) the test for determining such moment requires a practical assessment of the facts and circumstances relating to the likelihood of payment and any "identifiable event" which fixes the loss with certainty may be taken into consideration. The Tax Court then looked at Reg. Sec. 1.6050P-1(b)(2)(i)(H), which provides that one such identifiable event is the non-payment testing period described in Reg. Sec. 1.6050P-1(b)(2)(iv). That regulation, the court observed, provides that there is a rebuttable presumption that an identifiable event has occurred during a calendar year if a creditor has not received a payment on a debt at any time during a testing period ending at the close of the year. The testing period under the regulations is generally a 36-month period. The court noted that Reg. Sec. 1.6050P-1(b)(2)(iv) also provides that the presumption that an identifiable event has occurred may be rebutted by the creditor if the creditor (or a third-party collection agency on behalf of the creditor) has engaged in significant, bona fide collection activity at any time during the 12-month period ending at the close of the calendar year, or if facts and circumstances existing as of January 31 of the calendar year following expiration of the 36-month period indicate that the indebtedness has not been discharged.

The Tax Court rejected the IRS's argument that because the dealership took collection actions during the testing period, the presumption that an identifiable event occurred in 2008 was negated. The court found that, while the IRS established that collection agencies were engaged, the evidence did not demonstrate what, if any, collection activities they undertook. Thus, the court concluded, the IRS failed to provide any evidence of any significant, bona fide activity that would indicate an active creditor. The IRS thus failed to rebut the presumption that an identifiable event discharging Clark's debt occurred in 2008.

For a discussion of the determination of the year a debt is discharged, see Parker Tax ¶72,310. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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