How long does a lending institution have to issue a 1099-C (Cancellation of Debt)?
Dale Machalleck
The other day a new tax client called me and said he received a 1099-C (Cancellation of Debt) from an organization he had never heard of and wanted to know the relevance of this IRS document.
FACTS:
In 2019 client got a credit card from a bank. In 2020 client had maximized his credit card limit. During the same year client lost his job and stopped making payments on his credit card. Client never heard from the bank that issued the credit card. In 2023 client started receiving telephone calls, emails and text messages from a collection agency that apparently purchased the bad debt from the bank. Client ignored all collection actions and then in 2024 client received a 1099-C (Cancellation of Debt) from the collection agency. Client asked me for an explanation as to why he received the 1099-C (Cancellation of Debt) and whether or not he had to report this on his individual income tax return.
My explanation was as follows . . . in 2020 client had maximized his credit card limit and stopped making payments to the bank on his credit card. Generally Accepted Accounting Principles (GAAP) provide that a lending institution must establish an “allowance for doubtful accounts.” An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable. The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers. It is deducted from the total accounts receivable on the balance sheet to show a more realistic picture of expected collectible amounts. When companies account for bad debt expenses in their financial statements, they will use an accrual-based method, however, they are required to use the direct write-off method on their income tax returns. This variance in treatment addresses taxpayers’ potential to manipulate when a bad debt is recognized. Because of this potential manipulation, the Internal Revenue Service (IRS) requires that the direct write-off method must be used when the debt is determined to be uncollectible, while GAAP still requires that an accrual-based method be used for financial accounting statements. The 1099-C (Cancellation of Debt) has no “Date of an Identifiable Event” or a code for an explanation of the identifiable event.
Based upon the facts and circumstances of this bad debt, it appears the amount owed by client to the credit card company became a worthless debt in 2020. The credit card company had a allowance for doubtful accounts for the bad debt in 2020 and I presume would have taken a bad debt deduction on their 2020 of 2021 tax return.
QUERY:
Based upon the foregoing the unknown company that issued the 1099-C (Cancellation of Debt) in 2023 should never issued the 1099-C (Cancellation of Debt) because they purchased the debt from the original lending institution and therefore the cancellation of debt was actually between the original lending institution and the collection agency.
DEFENSE:
My position would be to include the 1099-C (Cancellation of Debt) as income on the individual income tax return and then take a deduction for an equal amount!
ATLANTIS FINANCIAL ORACLES, LLC
Dale R. Machalleck
Managing Director
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