Tax Consequences for Cancellation of Debt Income
Published On: February 28, 2010
What follows is a blog post written by my colleague,David N. Stonehill, Tax and Real Estate Attorney. I’m @HRMargo on twitter. As an HR and Social Media Consultant in his firm, I see sad stories like this every day. Employees are drowning in debt, particularly after the recession of 2009. Below is a case study, and a real story about one of Stonehill’s clients. He has since helped her out of this awful jam, but the fact remains clear. Our tax code has to change. It is my hope that those who read this post will become as outraged as we did. There is a way out. You are not alone. As you read this with an open heart, and mind, remember there are people out there, good people who can and will help you. Now, a few words from David Stonehill.
- I have a client who is a pensioner living in rural Vermont. She’s 70 years young, lives by herself in a modest home, and drives a beat up pickup truck. God bless her.
- And she had about $40,000 of credit card debt. She hired one of those debt consolidators, who actually did a pretty good job of negotiating her debt in half. They stretched the payments over a couple years.
- The problem is that this creates cancellation of debt (“COD”) income. One creditor sent her Form 1099-C to report about $5,000 of COD income for 2007. She didn’t know what to do with it, so she squirreled it away. The IRS assessed her about $1,000 for failure to report the income. She lost several nights sleep over this, because she did not have the money to pay the assessment.
- Another creditor sent her a Form 1099-C in 2008. Yet another was received for 2009. Who knows if COD income will be reported in 2010. She has absolutely no control if and when a lender issues Form 1099-C.
- The fix so far required: 1) a petition for reassessment for 2007, 2) an amendment of her 2008 tax return and 3) the filing of long Form 1040 for 2009. I got the 2007 assessment reversed, and avoided an assessment for 2008.
- The taxation of COD income demonstrates an utter failure of our federal tax code and treasury regulations. Without question, she can exclude COD income, because she is broke (“insolvent” in IRS-speak). Between social security and her pension, she doesn’t even make $20,000 a year. Yet she cannot file a simple, short form 1040-A!
- The Taxpayer Advocate has pointed out this problem to Congress. While there is merit to taxing COD income in complicated financial transactions, pensioners such as my client should be exempt. This is a senseless trap for the unwary. My client shouldn’t have to hire a tax lawyer to show the IRS why her COD income should be excluded anyway.
- For a good read, here’s a link to the Taxpayer Advocate’s 2008 report to Congress regarding the shortcomings of COD income taxation. I am not going to hold my breath waiting for the recommended changes, but I will work tirelessly on behalf of those who are dazed and confused by the maze of our tax system. For more information, contact us www.1099advisor.com Please feel free to reach us anytime at 877-IRS-1099.