Thursday, October 30, 2014

IRS Proposes Elimination of 36 Month Discharge of Indebtedness Reporting

Unless a statutory exception applies, when a debt is discharged without payment being made, the debtor will have discharge of indebtedness income under Section 108 of the Code. So that the IRS is alerted to this income, Section 6050P requires applicable financial entities to issue an information report to report the discharge of debt.

There are 8 events that give rise to this reporting – 7 of them relate to an event that coincide with an actual discharge of debt. One of them does not – under the 36 month rule reporting is required if no payment has been received on the indebtedness for 36 months (unless debt collection action occurs within 12 months or there are facts and circumstances showing the debt has not been discharged).

This can result in the debtor receiving notice on a Form 1099-C of a discharge, even though one may not really have occurred. There is no law that says that a debt discharge occurs either legally or for federal income tax purposes just because a payment hasn’t been made for 36 months.

This reporting can lead to various problems if the debt was not actually discharged. The IRS may initiate compliance activities based on the Form 1099-C, if the debtor does not report the corresponding income. The debtor may still be subject to collection enforcement activity from the creditor. The debtor may believe he has to report discharge of indebtedness income even though the debt has not been discharged. If the debt is discharged in a later tax year, the IRS may not be alerted to it in that later year.

For these reasons, the IRS has issued proposed regulations to remove the 36 month rule. Presumably neither debtors nor lenders will be interested in raising objections to this rule, and it will be made effective and incorporated in final regulations soon.

Prop Reg § 1.6050P-1

Thursday, October 23, 2014

Federal Tax Lien Did Not Survive Death of Joint Tenant

Two individuals (Cunning and Wren) acquired real property in the U.S. Virgin Islands as joint tenants with rights of survivorship (JTWROS) in 2005. In 2010 the IRS filed a federal tax lien against Cunning in the U.S. Virgin Islands. Cunning died in 2011, so that Wren succeeded to 100% ownership of the real property.

The IRS sought to continue its tax lien against the real property.The District Court in the Virgin Islands ruled that the lien died with Cunning such that Wren owns the interest free of the tax lien.

In most states, when property is held in joint tenancy with a right of survivorship, liens issued against a deceased joint tenant's interest in the property are extinguished when the deceased joint tenant dies and any other living joint tenants succeed to his share. Federal tax liens do not create any property rights in favor of the IRS beyond those that otherwise exist under state law.  United States v. Craft, 535 U.S. 274, 278. Thus, the IRS has the same rights, and only the rights, of other lienholders in the subject jurisdiction, and is subject to the above general rule in those states where the rule applies.

The legal theory of this general rule is that the surviving joint tenant does not obtain ownership by succession to the the rights of the first joint tenant to die. Instead, the survivor’s interests in the property were established at the time the property was initially conveyed into the joint tenancy. Thus, the survivor did not receive property subject to a lien against the first joint tenant, and that lien is extinguished.

The District Court determined that while there was no case law in the U.S. Virgin Islands on this issue, it believed the Supreme Court of the U.S. Virgin Islands would apply the above general rule. Thus, it found that the IRS lien died with Cunning.

NPA ASSOCIATES, LLC, v. CUNNING, EST, 114 AFTR 2d 2014-XXXX, (DC VI), 10/17/2014