If a taxpayer who has borrowed money from bank defaults on repayment and does not repay the bank, the taxpayer will have cancellation of indebtedness income to the extent that the amount due the lender exceeds the value of any mortgaged property taken or foreclosed upon by the bank. Banks are required to submit a Form 1099-C “Cancellation of Debt” form with the IRS and taxpayer showing this cancellation of indebtedness income, and the taxpayer is required to report that income unless some exclusion from income applies.
That is what a lender did in a recent Bankruptcy Court case. However, the lender then sought to collect the difference between the amount due and the value of the mortgaged property against the borrower (who at that time was in bankruptcy). Interestingly, the Bankruptcy Court found that the debt had been discharged, and thus the lender could not collect its deficiency.
The filing of the Form 1099-C itself did not discharge the debt of the borrower. However, based on IRS Regulations indicating when the Form should be filed, by filing it with the IRS the bank was representing that the debt had in fact been cancelled at that point. Thus, the borrower was able to use that representation to evade liability for the debt.
This is probably not the last we will hear about this issue, as there are other courts that disagree with this conclusion.
Note, however, the Bankruptcy Court did allow the bank’s claim for interest, costs, and attorneys fees that were due under the loan documents to remain, since the Form 1099-C rules do not involve a determination that these amounts have been cancelled.
In re William Stanley Reed and Debbie Elaine Reed, Case No. 12-30049 (Bkrptcy Ct Eastern District of Tenn)