A situation arose in a case when a taxpayer received Form 1099, which usually means you have also received taxable income. However, in this tax law case the ruling went in favor of the debtor.
The specific From 1099 involved in the Tax Court case was Form 1099-C, issued when a taxpayer has unpaid debt forgiven by the creditor. This information form is filed because such amounts generally are taxable income. From state to state the statute of limitations on noncollectable debt varies, but according to the Federal Trade Commission the time limit is between three and 10 years.
Sometimes this dead debt comes back to haunt debtors. That’s why it’s often referred to a zombie debt. OH NO, ZOMBIES!
If you have received a collection notice several years after the debt has been incurred, you should send a cease and desist letter to the collector explaining that the time allowed to collect the debt has expired. If the collector persists and ultimately files suit to collect the too-old debt, be sure to show up in court with evidence that the statute of limitations for collection purposes has expired.
In most cases, when debt is canceled, the amount you don’t have to pay is taxable income and canceled debt also is not taxed in cases of insolvency or bankruptcy.
One exception that’s gotten a lot of attention because of the horrid housing market mortgage debt canceled in connection with foreclosures. In some of these cases, the homeowners do not owe taxes on the forgiven debt.
If you happen to find yourself in a cancellation of debt situation where the amount is not taxable income (insolvency, bankruptcy or mortgage related debt forgiveness), you can file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).
So be aware that zombie debts are quite real and instead of using weapons to stop them from killing you, know your states tax code.
CreditCards.com has a cool interactive map you can use to see the rules for your state.
JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.