I’ve discussed the taxability of debt cancellation before. If you owe a debt and the debt holder agrees to forgive that debt, they can issue you a 1099-C for the amount you owe. The income reported on the 1099-C is then included on your 1040 return and taxed.
In a new Tax Court Summary ruling (TC 2012-46) gave the debt holder 36 months after writing off the debt to issue the taxpayer the 1099-C. The case involved a taxpayer who defaulted on a credit card bill in 1996. The bank behind the credit card discharged the debt that year. However, in 2007, the bank sold the debt as part of package to a collection agency. When the collection calls began, the taxpayer sent a letter to the collection agency telling them to stop their collection calls. So, the company issued him a 1099-C in 2008 which he did not include on his 2008 tax return. The IRS sent him a notice of deficiency and the case ended up in Tax Court. The Tax Court’s ruling gives creditors some time to make sure that the taxpayer is not going to pay on the debt but limits how long they can string out the debt before issuing the 1099-C.
Banks and other creditors often bundle debts and sell them off to bill collectors. But recently they are including old debts or debts that have been paid off. Bank of America and JP Morgan Chase were highlighted in an American Banker series about this practice. For a customer who has paid off their debt, this means they have to prove to the collection agency that they paid the debt. A customer who thought the debt was discharged years before could find that they once again owe the debt if they don’t handle the new collections efforts properly.
Each state has a statute of limitations when it comes to unpaid debt. The most is 10 years. If the customer doesn’t pay on the debt for those ten years, the creditor can’t sue you to collect. The customer is still morally liable for repayment and can choose to repay but the creditor can’t legally force them to pay. And after 7 years, the debt should be purged off the customer’s credit report. However…If the creditor sells the debt to a collector or tried to collect it themself and the customer is not careful how they respond to the new collection calls, the debt can be put back into play even if it’s past the statute of limitations. The triggers depend on the state. Something as simple as agreeing that you owe or paying some on the old debt could make it new again. And start a new statute of limitations.
If you find yourself in this situation, don’t let the collector get the upper hand. Find out what your state’s statute says and review the FTC’s Fair Debt Collection Practices. If you get a 1099-C for a long ago debt, you may be able to exclude it from income based on the Tax Court’s ruling. But understand that the burden of proof will be on you.
Or you could pay the debt.