Today's Trends in Credit Regulation

Forgiveness Isn’t Easy . . . and May Have Tax Consequences
By H. Blake Sims

The great 18th-century English writer/poet Alexander Pope wrote: “To err is human, to forgive, divine.” The Internal Revenue Service may agree with Pope, but it still wants its tax dollars. In the eyes of the IRS, when you forgive a customer’s debt, the customer actually realizes income because the forgiveness frees his assets.

Generally, when an “applicable entity” discharges debt of at least $600, the entity must file a 1099-C information return with the IRS and send a payee statement to the individual whose debt was forgiven. In lending transactions, only discharge of principal is required to be reported. The IRS does not require aggregating multiple discharges of debt of less than $600 but does prohibit splitting the debts to avoid the 1099-C requirements. “Applicable entity” applies to numerous organizations, including those “the significant trade or business of which is the lending of money.”

The IRS does not consider “seller financing” a significant trade or business of lending money. Therefore, when retail sellers extend credit to customers to finance purchases, the seller is not an “applicable entity.” Also, an organization engaged only in lease transactions is not required to report discharge of debt because leasing is not lending money for purposes of IRS Code section 6050P.

“Great!” you say. “Then why am I reading this boring article about taxes?” Unfortunately, the seller financing exception does not carry over to a retail seller’s separate financing subsidiary. So, if your business has a related finance company [RFC], a significant business of which is lending money, the RFC is considered an “applicable entity.” If an organization is engaged significantly in lending money and in leasing transactions, the organization is required to report the discharge of any amount owed to it, including fees, administrative costs, and fines for the non-lending transactions.

If your business does not have an RFC, you can stop reading, but since you have made it this far, why not just be a hero and trudge onward?

An RFC must be concerned about the 1099-C issue only if there is a discharge of debt. A discharge of debt occurs only if there is an “identifiable event.” The IRS regulations provide a list of eight such events. There are three identifiable events that the creditor controls: (1) a discharge of debt under an agreement between the parties, (2) a discharge based on a creditor’s decision or a defined policy to discontinue collections, and (3) expiration of a 36-month nonpayment period. The nonpayment event is the subject of a pending IRS bulletin and may be eliminated or revised. The creditor can rebut the presumption that an identifiable event has occurred if the creditor conducts “bona fide collection activity” during the 36-month period. Bona fide collection activity does not include nominal or ministerial collection actions, such as an automated mailing. Tax courts, however, look to more than merely the identifiable events when deciding if a discharge has occurred. They have held that “the moment it becomes clear that a debt will never be repaid, that debt must be viewed as having been discharged.” Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). The courts have also held that a bookkeeping entry alone does not result in a discharge. Determining if a discharge has occurred can be complicated, so RFCs should establish policies to address the issue.

Sending a 1099-C may result in some angry phone calls. Remind the customer that paying the tax is less than paying the debt, or tell him or her to just blame the IRS or Congress. My guess is the latter option will work better. Regardless, you must act to avoid penalties for non-compliance. In general, the creditor must pay $100 for each information return and each payee statement it fails to provide ($250 each if deemed an intentional disregard of the requirement). Total penalties are capped at very high amounts and may be reduced based on timely corrective actions. Be aware that an RFC is required to maintain a copy of each 1099-C form it files for at least four years from the required date of filing.

Remember, I am not a tax attorney, and this stuff is complicated, so you may want to discuss this issue with your tax advisors. One thing we can be sure of is that Benjamin Franklin was right: “The only things certain in life are death and taxes.”

H. Blake Sims is a partner in the Tennessee office of Hudson Cook, LLP. Blake can be reached at 423-490-7563 or by email at

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