The King of Zombie Debt: The 1099-C. What to Do When Collection Continues After Receiving a 1099-C
By Gregory M. Fitzgerald, Esq.
Most folks who get a 1099-C accept that it is a good news/bad news thing. The bad news is you must include the 1099-C as income on your taxes. The good news is you no longer owe the creditor. Not so fast says the creditor. Creditors and their collectors are telling consumers that a 1099-C does not release the debt. This approach by creditors is becoming more prevalent and I suppose I shouldn’t be surprised. Courts are struggling with conflicting laws/regulations and seem to have dodged the central issue: is the debt cancelled or not? The failure to provide clear direction has allowed creditors to misinterpret court opinions, often misleading consumers. In my view, even consumer advocates have incorrectly applied fact specific rulings and appear to accept a general rule that collection can continue after a 1099-C. I strongly disagree.
First, let’s be clear what we are talking about. If you settled your debt for less than the full balance and the creditor sent you a 1099-C for the amount they “forgave” or “cancelled”, there should not be a problem. I say should because if you are getting collection contacts in this situation, you have a different zombie debt problem: collection of a debt paid or satisfied in full. No less a problem to be sure, but not the problem I am addressing here. Another important clarification is that terms such as “charge off” and “written off” is not synonymous with “cancelled” or “forgiven”.
What I am reviewing in this article is the circumstance where a consumer gets a 1099-C, generally for the entire account balance, and then gets collection contacts trying to collect the debt. Many times the 1099-C is the first and only indication the consumer receives that the debt has been cancelled by the creditor. This means the creditor is reporting to the IRS that it has cancelled the debt, thus creating taxable income to the consumer (taxable income does not automatically equate to a tax liability). Nor is this an article about the tax implications of a 1099-C. Rather it is about the status of the debt and whether a debt is owed after receiving a 1099-C.
On the 1099-C in big bold letters at the top it says: Cancelation of Debt. When consumers get a 1099-C the second question they generally ask is: do I still owe the money? (The first is do I have to include it in my taxes). People inherently understand that it can’t be both. After all, how can you still be responsible for the debt when you are supposed to claim it on your tax return? You can’t be on the hook for both right? Unfortunately, many creditors will have you believe you are still responsible for the debt. They are wrong. You as the consumer cannot be forced to both pay a debt and show the debt as income. But be prepared to fight as this debt zombie is particularly resilient.
The creditor’s argument is basically one or both of the following: The fact that IRS regulations require them to issue a 1099-C under certain circumstances does not modify the consumer’s financial obligation to them. The underlying contract with the consumer has not been altered by the “mere filing of a 1099-C”. Stated differently, the creditor believes that the IRS reporting regulation does not eliminate your duty to pay the debt. An alternate theory is that they issued the 1099-C by mistake. Creditors and their surrogates like to tell consumers only half the story and hope you will fail to look further.
What the creditor neglects to tell you is that all courts have understood the obvious issue that the debt cannot be both: 1) cancelled and 2) still due. That is, you can’t still owe 5K on your Discover account and also be forced to claim 5K as income. I don’t know of a single case where the court has allowed the creditor to collect after issuing a 1099-C without also requiring the creditor to issue an amended 1099-C. An amended 1099-C is essentially a corrected 1099-C that states no debt was cancelled. This basically allows the creditor to “unwind” or retract the 1099-C they previously sent to you.
Most judicial opinions have focused on what factual evidence supports the creditor’s true intent in determining if the debt was canceled or not. That is, was the 1099-C, in fact, issued by mistake? Did the creditor never intend to give up their rights and only issued the 1099-C because IRS regulations required them to? My personal view is that the IRS regulation requiring a 1099-C be issued is more than just a reporting function. The IRS is compelling the creditor to report what has in fact occurred- the debt has been cancelled, either in fact or by operation of law. It is illogical to say one must report a cancelation of debt to the government and the debtor, but if you don’t really want to cancel it, you have not cancelled it. That is an article for another day and a thorough review of the IRS regulations will be enlightening (fun stuff). For now, let’s review the existing cases, learn what they really stand for, and see how they can assist the consumer today.
In the Indiana case of Leonard v. Old National Bank Corporation, 837 N.E. 2d 534 (2005) the consumer had filed for bankruptcy and the bank then issued a 1099-C thinking they were required to do so because of the bankruptcy filing. However, IRS regulations require the 1099-C upon bankruptcy discharge (as opposed to the mere filing). The bankruptcy was actually dismissed prior to discharge. The trial court found that this error showed the bank did not intend to cancel the debt and only issued the 1099-C because they mistakenly thought they had to.
In Zilka v. Bayer Employees Federal Credit Union 407 B.R. 684 (2009) [a U.S. Bankruptcy Court case in the Western District of Pennsylvania] the court held: “Bayer obviously filed and issued the four forms 1099-C in response to its charging off of the outstanding indebtedness of the four loans… therefore, Bayer filed and issued the four Forms 1099-C … in error which can be corrected”. The court then ordered Bayer to issue to the debtor four corrected forms 1099-Cs. Again, the issue was mistake. An unpublished opinion (not to be cited as a legal authority) is the California case of Far East National Bank v. Nolan Financial Corporation (2005 Cal. App. Unpub. LEXIS 9584). Here, the bank issued a 1099-C, then filed suit, and then filed an amended 1099-C. As a factual matter, the court found there was “substantial evidence of a mistake” in issuing the original 1099-C. Thus it is clear that in order for a creditor to claim mistake in issuing a 1099-C, the creditor must prove with facts that it made a mistake and must issue a corrected 1099-C before they can pursue the debt. Further support for the requirement that an amended 1099-C be issued before a creditor can pursue a debt is the Kansas U.S. Bankruptcy Court case of In re Crosby, 261 B.R. 470. The court wrote: “the Credit Union contends that it filed the 1099-C’s with the IRS under a mistaken interpretation of the agency’s regulations, and that its mistake does not affect its right to collect from the debtors, even though it has made no effort to file corrected 1099-C’s…The Court cannot agree”. The Court concluded “Until the Credit Union corrects or withdraws the 1099-C it mistakenly filed about each debtor, it cannot enforce its claim against that debtor”.
In Amtrust Bank v. Fossett, 224 P.3d 935 (Ariz. App. 2009) the court ruled: “We hold that while issuance of a Form 1099-C may be prima facie evidence of cancellation of a debt, the lender may rebut that evidence by showing that when it issued the form it did not intend to forgive the obligation…” In this case the appellate court sent the case back to the trial court for a factual determination of intent. Another often cited case to support the proposition that just because the IRS requires a 1099-C does not mean the debt cannot be enforced is Debt Buyers’ Association v. Snow 481 F. Supp. 2d 1 (2006). This was a case brought by the Debt Buyers Assn. which sought an injunction to prevent the Secretary of the Treasury and the IRS from enforcing the IRS regulations regarding 1099-Cs. This was prompted by creditors issuing 1099-Cs on accounts purchased by debt buyers. Debt buyers made the sensible argument that by issuing 1099-Cs on sold accounts, creditors were, in effect, selling accounts that could not be collected on and therefore rendered the purchased accounts worthless. The court refused to determine the case on the merits, finding the case brought in the wrong court. The court did opine that the IRS regulations had nothing to do with whether or not the debt could be collected on and debt buyers could, to avoid any FDCPA violations, issue to consumers an “instructional guideline” or “disclosure” stating why the 1099-C was issued, despite the debt still being due. Therefore the consumer would get conflicting information.
It seems to me that we have somehow gotten to the point where “cancelation of debt” does not actually mean “cancelation of debt” anymore. If the creditor doesn’t want it to mean that, apparently they don’t have to. That is why I call the 1099-C the King of the Zombie Debts: you can receive a government mandated “cancelation of debt” on a government mandated form, and under threat of government force must declare it as income, AND STILL THE DEBT IS NOT DEAD! What bigger zombie debt can there be than government required (IRS) and government approved (courts) zombies? Amazing.
One final case to note is the US Tax Court case of is Sims v. Commissioner , T.C. Summary Opinion 2002-76 (T.C. 2002).This is another unpublished (and should not be cited as authority, although it often is) case wherein the IRS wanted the consumer to pay additional taxes because the 1099-C was not on their tax return. Sims argued that they never got the 1099-C and for various reasons there was no proof the debt was ever actually cancelled by the creditor. The Court agreed stating: “Based on the record before us, we find that the petitioners did not have discharge of indebtedness income during 1998?. Creditors cite this case as supporting their belief that the mere issuing of a 1099-C does not extinguish the debt. That is not the ruling. The ruling was that there was insufficient evidence to conclude the requisite intent by the creditor to discharge the debt ever happened. Again, a factual determination.
Amending the 1099-C when in fact the original 1099-C was sent in error is fair enough I suppose. But the question remains was the original 1099-C actually sent in error? Although this is a factual question, creditors would have you believe that they can, as a matter of right, file an amended 1099-C and all is well. I contend that until such time as the amended 1099-C is issued, any collection effort on that account is unlawful because until such time as the corrected 1099-C is issued, there is no valid legal obligation to be pursued. It is common for a collector to not even know a 1099-C was issued until the consumer tells them.
As to the mistake issue, I’m sure this sometimes happens. I’m also sure that many times the mistake was not in issuing the 1099-C but rather the collection of an account after issuing the 1099-C. The creditor always alleges a mistake as a way to avoid liability for collecting on a debt they cancelled. In my experience, the vast majority of mistakenly issued 1099-Cs are caught by the creditor close in time to its issuance, not years later. I am always leery of a creditor who issues a 1099-C in 2009 and in 2011 says it was a mistake. Particularly when they discover the mistake after trying to collect. Also, mistakenly issued 1099-Cs are usually in bulk. That is, it is not some lone account that somehow got screwed up. It’s usually a whole portfolio or class of accounts that were treated improperly.
If in fact the creditor has made a mistake, parameters should be established as to how long the creditor has to correct it and how. As it stands now, a consumer cannot really rely upon the 1099-C. The fact is consumers are being forced to pay increased taxes only to later discover that the creditor made a “mistake”. Sure, you can pay a professional to amend your return, and sure Uncle Sam is supposed to give you a refund, but why is the consumer, who made no mistake, carrying the burden of mistakes by creditors?
Another problematic issue is what if the amended 1099-C is issued more than 3 years after the initial 1099 so that the consumer can no longer amend their tax return? The truth of the matter is that cancelation of debts and the attendant tax consequences (if any) is not something creditors should be allowed to treat so cavalierly. If required to cancel the debt by the IRS, the debt should be cancelled, regardless of the intent of the creditor.
If the creditor makes a mistake, the creditor, not the consumer, should bear the responsibility. A consumer (and the taxing authorities) should be able to rely on a 1099-C and, at a minimum, absolutely no collection efforts should be allowed until any “mistake” is rectified.
To conclude, if you received a 1099-C and now someone is trying to collect the debt, don’t be afraid. Don’t believe everything you are told. Your IRS obligations have nothing to do with whether the debt has been cancelled or not. As between you and the creditor, the only issue is: has the debt been cancelled by the issuance of a 1099-C? I say yes. This is undeniable. Zombies are not real. It is the creditor’s burden to establish otherwise. If you are told the 1099-C was issued by mistake, do not accept this at face value. Demand to know what the mistake was. If you are told there was no mistake but the IRS required the 1099-C, demand to know which IRS code they are relying on. And by all means, demand that an amended 1099-C be issued before you pay anything. Even the King of Zombie debts can be contested and defeated.
This article is not legal advice and should not be interpreted as such. It is provided for informational purposes only. You should consult legal counsel about your specific circumstances and law before making any decisions about your legal rights and how to protect them.
Gregory M. Fitzgerald is a California licensed attorney located in Anaheim Hills CA (Bar #153082). For over 20 years he has represented consumers with a particular emphasis in consumer rights in the field of debt and debtor harassment. He is a founder of Fitzgerald Campbell, A Professional Law Corporation. He is admitted to practice before all California State Courts and all Federal District Courts within California. He is a member of the Orange County Bar Association. He formerly sat regularly as Judge Pro Tem for the Orange County Superior Court. He can be contacted at (866) 927-8289, firstname.lastname@example.org or via the web at debtorprotectors.com