Taxing Lessons Case Summaries

Case — Cancellation of Indebtedness

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TL Case Summ

THE QUESTION

Can the IRS rely solely on Form 1099-C as evidence of cancellation of indebtedness income?

THE DISPUTE

Taxpayer Says: Form 1099-C does not reflect the true income required to be reported.

Internal Revenue Service Says: Taxpayer is required to report the amount shown on Form 1099-C as taxable income.

THE LAW

From Internal Revenue Code Section 61(a)(12): Generally, a taxpayer must include in gross income amounts from the discharge of indebtedness.

From Cronin v. Commissioner, T.C. Memo. 1999-22: Where indebtedness is being discharged, the resulting income would equal the difference between the amount due on the obligation and the amount paid, if any, for the discharge.

From Rule 142(a)(1): In general, the Commissioner’s determination in a notice of deficiency carries a presumption of correctness, and the burden is on taxpayers to prove otherwise.

From Internal Revenue Code Section 7491(a)(1): Under circumstances prescribed by statute the burden may shift where a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the income tax liability of the taxpayer.

From Internal Revenue Code Section 6201(d): In any court proceeding, where a taxpayer asserts a reasonable dispute with respect to any item of income reported on an information return, such as a Form 1099 filed by a third party, the Commissioner may have the burden of producing reasonable and probative information concerning the deficiency in addition to information on the information return.

THE CAUSE OF THE DISPUTE

Generally, when you are personally obligated to repay a debt that is later cancelled by the lender, the difference between the balance you owed at the time of the debt cancellation and the fair market value of the property used to secure the debt is ordinary income to you. (Exceptions are available, such as qualified mortgages, bankruptcy and insolvency.) The presumption is that you received an economic benefit equivalent to income by not having to repay the full face value of the debt.

The lender is required to report amounts of cancelled debt in excess of $600 on Form 1099-C, Cancellation of Debt. The IRS typically assumes Form 1099-C is correct.

In this case, the taxpayer stopped making payments on a personal vehicle. The lender repossessed the vehicle and issued Form 1099-C showing the amount of the outstanding loan balance as cancellation of indebtedness income.

While the taxpayer and the IRS agree the debt was cancelled, the taxpayer says the value of the vehicle at the time of repossession was the same as the outstanding debt, leaving no taxable income. The IRS says the forgiven debt reported on Form 1099-C is the amount of taxable income.

Neither the IRS nor the taxpayer offer evidence beyond the lender’s records, which show that the taxpayer purchased a 1988 vehicle in 1999 for $12,360.48, and that the vehicle was repossessed in 2002 when the loan balance was $6,704.92.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 13KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Right answer!
Sorry, wrong answer :(
For the Taxpayer. Taxpayer effectively called into question the validity of Form 1099-C and IRS has not placed in evidence any information that would rebut his testimony, which is also supported by documentary evidence in the record. Therefore, in accord with section 6201(d), IRS is not able to rely solely upon Form 1099-C in support of the determination that taxpayer has cancellation of indebtedness income. Taxpayer is not required to report cancellation of indebtedness income.
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