As the year ends, many banks are preparing to issue Forms 1099 for 2012. Beginning in 2013, Form 1099-C will require a new code. The new codes will show the reason the bank issued the Form 1099-C. This new requirement provides banks an opportunity to review their Form 1099-C procedures and to put systems in place to identify the correct trigger event codes for Form 1099-C.
What Is Form 1099-C?
Form 1099-C is an information return used to report canceled debt to debtors for tax purposes. A debtor does not have income when an amount is borrowed. But, if the debtor does not pay the loan back and the bank forgives part of the loan, then the forgiven portion of the debt constitutes taxable income to the debtor. For example, if a customer takes out a loan for $100 and the bank agrees to discharge the loan for $75, then the customer would have $25 in forgiveness of debt income. Form 1099-C is generally used to report this forgiven-debt income. The debtor will generally owe taxes on forgiven-debt income unless the debtor is able to claim an exception from taxation, such as for insolvency.
When Do Banks Issue Form 1099-C?
Lenders are generally required to issue Form 1099-C after certain trigger events on a debt. These events are identified in tax regulations. Common trigger events include:
- Debt settlement agreements
- Expiration of the statute of limitations on collecting the debt
- No payments on a debt during a 36-month testing period (unless the creditor actively engaged in collection activity)
- Most other events that would cancel a debt, such as foreclosure proceedings or probate proceedings.
(Note that many special rules and exceptions apply to the trigger events, which are not covered in this column.)
Once a trigger event occurs, a bank generally must issue Form 1099-C—_even if the bank still considers the debt collectible. These trigger events have existed for years, but in 2013 the lender must put a code on Form 1099-C (the "Identifiable Event Code") to report the event that triggered the Form 1099-C.
Some lenders hesitate to send Form 1099-C on debts fearing that the debt will not be collectible after issuing the form. However, Form 1099-C is a tax form and banks should issue it as required. Issuing Form 1099-C does not necessarily mean that the lender can no longer collect a debt, at least according to the tax regulations. (While some state courts have barred a lender from collecting a debt if the lender has issued Form 1099-C, the law is not settled in all jurisdictions. In Wisconsin, there are no published opinions holding that a Form 1099-C conclusively discharges a debt.) Accordingly, lenders should send the Form 1099-C after an applicable trigger event.
Which Code to Use on Forms 1099-C Issued for 2012?
The new codes for trigger events appear in the 2012 instructions for Form 1099-C. Brief explanations of each code are set forth within the instructions under the section labeled "When Is a Debt Canceled." The new codes will be input on 2012 Forms 1099-C in Box 6 labeled "Identifiable Event Code."
What Does the New Code Mean for Banks?
With additional information on trigger events, the IRS could potentially review the codes to determine if banks are properly issuing Forms 1099-C. For example, if a bank rarely uses a code, it is possible the IRS could question whether the bank is under-reporting debts under that code.
These new codes provide an opportunity for banks to review their Form 1099-C reporting procedures. Banks should review their Form 1099-C processes to ensure that trigger events for each debt will trigger a Form 1099-C on that debt. Banks should also start tracking specific trigger events within their systems so that they can use the appropriate codes on Form 1099-C.
This column is general information and is not legal or tax advice. It is not intended to be used and it cannot be used to avoid any tax penalties. Consult your tax advisor with any questions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.