Fees paid to a company to settle credit card debt & cancellation of debt income

Ok, that all makes sense. But then I don't understand exactly where to draw the line between rebates/discounts and cancellation of debt. In some cases they look very much the same.

When it comes to taxes.... sometimes everything is in the eyes of the beholder and.. sometimes everything is in the eyes of the revenue agent.

Thought you might all find the attached interesting as it deals with CoDI. It comes from the blog of Joel Schoenmeyer, Atty @ Law

March 1, 2010 The Cancellation of Indebtedness "Scam"

Here's a (seemingly) new credit card company practice that looks like a scam:

A decedent dies in early 2007, and her estate goes through probate. The administrator discovers an outstanding credit card balance of about $17,000, and sends notice to the credit card company of decedent's death and the probate. (The administrator also asks for more information about the balance, as there's some evidence that the decedent's credit card may have been stolen prior to her death.)

In response to the administrator's questions, the credit card company does nothing. It files no claims against the estate and, as time passes, all claims against the estate become barred under Illinois law. The estate is closed in late 2008, and all is quiet.

Then, out of the blue, a form 1099-C for the year 2009 arrives in the administrator's mail. On it, the credit card company shows that it forgave indebtedness to the decedent in the amount of $17,000 on November 11, 2009.

A form 1099-C has two effects:

1. Generally speaking, debts that are forgiven are treated as income to the debtor. And the form 1099-C is sent to the IRS.

1. Forgiven debts can be deducted by the credit card company on their tax returns.

To me, it looks like the credit card company is running a scam. The credit card company knows that, because of its own incompetence, the debt is no longer valid under Illinois law. Yet the credit card company wants its deduction, so it pretends that the debt is valid. And the fact that an innocent estate has to pay -- by forking over the tax on the "income," or by hiring professionals to fight the tax -- is beside the point to them. This seems like the credit card company's modus operandi -- I've heard from other attorneys who encountered the same situation with the company.

Posted by Joel A. Schoenmeyer

In general, yes.

To the extent they don't get back money they have already paid tax on. For interest they haven't paid taxes on in that year, they get no deduction.

First of all, if it was a legitimate debt, the estate should recognize income, because it didn't have to pay what it should have. And if the debt was not legitimate, it would (and should) be able to prove that to the IRS.

Law

I don't see how this can be a scam. If the credit card company was on a cash basis then they wouldn't have reported the 17k as income because they never received it, so they should not be able to deduct it even if they issue a 1099-C (is that right?). If they were on an accrual basis, then they record the 17k as taxable income. Writing off the 17k makes perfect sense, 'cause why should they pay tax on money they never received.

They also have a "reserve against losses" that should increase by $17k and therefore there's no effect on income.

They won't; they'll carry the $17k as "uncollectable" and "reserved against" with no net tax effect.

For that matter, writing it off (without formally forgiving it) should still avoid them paying taxes on it.

Seth

I'm going to disagree with Mr. Bronstein here. It was also stated that this action took place after the PERIOD OF LIMITATIONS to make a claim against the estate in the probate proceeding. Therefore, I consider the action as barred by statute and there is no CoD income. Even if the 1099-C were timely, as the creditor filed no claim to the court, they lose anyway.

My understanding has always been that the expiration of the statute of limitations resulted in cancellation of debt income. These two Tax Court cases recognize that rule: Zarin 92 T.C. 1084 (1989) and Miller Trust 76 T.C. 191 (1981).

I read Miller and I have to agree with Stuart. The Illinois statute bars the bank from seeking a remedy. It does not invalidate the debt. As such, when the bank determined the receivable was uncollectible, it canceled the debt and issued the

1099-C. This creates CoDI for the estate as it was the estate that the credit card liability passed to upon death. As long as the IRS makes their claim within the 3 year (6 years if the amount is big enough to trigger the 6 year rule) statute of limitations from the filing of the applicable 1041, I don't see how the estate can avoid paying unless the estate was insolvent before it was terminated.

If one cannot seek a remedy (to collect it), there is no debt. That's why I disagree. It doesn't become CoD income (or a bad debt) just because the creditor was too LAZY to pursue it.

Had the creditor interceded into the probate and established their debt (thus time barred only), then my answer would be different.

My position is based on basic contract law: It has to be enforcable to be valid. Choosing not to enforce it doesn't mean it was ever valid.

Ok, that makes more sense. You are saying that the creditor didn't file a claim with the bankruptcy estate within the time provided, so the debt never arose. And if there was no legal debt, there can't be cancellation of debt income. I'll agree with the general concept.

The problem with that is that in Alan's example the debt was a true debt of the deceased. Are you saying that when someone dies any debt he owns immediately becomes void? It's still an enforceable debt. It's just that the statute of limitations becomes shortened when the debtor dies.

You could likewise say that there's never be any cancellation of debt income unless there was a judgment for the amount owed, because the debt hadn't become enforceable enough. It's just not the case.

That's what Miller says. The debt didn't disappear just because the creditor was barred from collecting it by the State statute. Upon canceling the debt it became income to the estate.

Yes, but it was a probate estate, not bankruptcy.

The OP said that the creditor was notified of the probate proceeding and FAILED to assert their claim. It was the probate procceding's period of limitations that invalidated the debt. By failure of the creditor to assert his debt in probate, there is no debt, and therefore, no COD income.

Wrong conclusion. By failure of the creditor to assert his debt in probate, the debt wasn't cancelled: Legally, there was no debt. Therefore, no CoD income.

But you could say that anytime the statute of limitations expires. It was there until it wasn't. In the case of an estate the debt was real, it was legal and it was collectible. The creditor just blew the statute of limitations.

That's just like any creditor who FAILS to assert a claim before the expiration of the statute of limitations.

The debt wasn't invalidated. It was just uncollectible.

Again, you could say the same thing about any statute of limitations situation. Once the statute passes, the debt becomes uncollectible. There is no debt. But in the process going from there being a debt to there not being a debt, not having to pay what once had to be paid is considered taxable.

Years ago I remember hearing about a case where the IRS determined that someone underpaid his taxes by a large amount, but they failed to collect within the statute of limitations period. So they claimed the unpaid tax was cancelled debt income, and they went after him at least for the tax on that.

No, it's not. The creditor is required to prove the debt to the court. Failure to do so isn't the same as letting time run out. Why is it different? Because, the court determines that there is no debt, not that an existing debt is cancelled.

Wrong. By not stating a claim, the probate court finds there is no debt.

You and I are both located in California, so I'll assume you're talking about California probate law. The laws of other states may be different.

When someone dies it is not necessary for a creditor to prove its claim in court. It is permitted for the executor to pay claims without the creditor even filing a proof of claim

If the creditor files a proof of claim within four months of being notified of the probate, the executor decides whether it is a valid claim. If the executor thinks it's proper, he is required to pay it. If he doesn't, the creditor has the right to sue.

Probate Code §9002(b) says,

" A claim that is not filed as provided in this part is barred."

It doesn't say that a claim not filed on time is void. It doesn't say it doesn't exist. It says it is barred. Whether it is valid or not, the creditor is simply barred from collecting.

Most of the time the probate court finds nothing at all, because overwhelmingly most obligations of estates never come before the judge.

Now if the creditor files a timely claim, the claim is denied and the creditor sues and loses, in that case there was no valid claim. But that is the exceptional situation.

I'm confused. Am not familiar with this "reserve against losses" concept -- is there a line on form 1120 or Schedule L for it? I'm familiar with Schedule C, so this may be beyond me.

Here's my thinking. When you buy 17k of stuff on credit card, the credit card company pays the payer right away. At least that's how I think it is, because when I buy on EBay and pay by credit card, the person receives the money right away and ship right away (they only ship when they receive the money). But if you pay by eCheck, it takes

5 days to clear and they ship then. But my credit card bill is due about one and a half months later and I can choose to not pay, or I can forget. So how does it look from the credit card company's point of view? Their reserves have gone down by say 17k minus fees, and say the fees are $200, so they have a loss of 16,800. If they are on the accrual basis they report 17k income. So they have net income of $200 (which is just their fees on the 17k). But when the person defaults, the credit card company has to deduct the 17k of income that they included in their income earlier but never received.

And what if the credit card company sells the debt for 1k to a collection agency? The accounting gets really complicated then.