Debtor defaults on a $2000.00 credit card. Because of fees and interest, the debt nearly doubles. The credit card company sells this debt to a third party. Third party sues debtor for over $5000.00 including attorney's fees. If a settlement is reached for $2000.00, would this be considered income due to a cancellation of debt?
Interesting question.
My thought is no, there's no cancellation of debt income. There's cancellation of claimed debt, but not of established debt. If there were taxable income in this case, you could cause anyone to have taxable income by telling him he owes you money, and then telling him "never mind."
You lost me with your comment "but not established debt." The taxpayer defaults on $2000 of credit card charges. Each month finance charges add to the outstanding balance. Let's say the balance reaches $4000 when the issuing bank decides to discount the debt and sell it to a collector. The debt is $4000 when it is sold at some discounted amount. The collector is betting that they can make a profit by collecting the $4000 or some lesser amount that is still above what they paid. If the taxpayer enters into a settlement for $2000, I believe there would be debt cancellation income of $2000 (the difference between what the taxpayer owed to the bank and what the taxpayer paid).
Did the bank thereby cancel the cardholder's debt with this action?
They actually tried to collect $5,000, including attorney's fees.
Somewhere, maybe on this board, I collected an article on this very topic, from "Tax Analysts - Tax Notes December 15, 2008" by author Richard C. E. Beck (professor at New York Law School).
Here's an excerpt:
"The Tax Court has recently held in Payne v. Commissioner that the forgiveness of defaulted interest is taxable to the borrower, and in Hahn v. Commissioner that forgiven penalties are taxable as well. This article argues that those decisions are erroneous. Because those judicial errors will potentially injure millions of taxpayers, it is important that the errors be corrected. Payne is currently on appeal before the Eighth Circuit and should be reversed."
-Mark Bole
No. It sold it. The outstanding balance remains the same.
I don't believe the attorney fees are relevant for purposes of debt cancellation. The debt cancelled was the amount owed (in my example $4000) less what was paid.
I've changed my mind on the interest and finance charges as taxable income. I started to think about a recourse mortgage debt and realized the cancelled debt including interest is taxable because the interest is tax deductible. Therefore, I must conclude that as long as we are discussing personal debt (not business debt), only the amount charged would be taxable less any repayment.
But in getting from $5K lawsuit amount to $2K settlement, how much of the $3K difference represents canceled principal, canceled interest, and canceled attorney's fees? If the third party collection agency is going to issue the 1099-C, I wonder what determines the amounts they put in Box 2 and Box 3? Maybe it gets spelled out in the court decree?
I d "If the interest would be deductible (such as on a business loan [or qualified mortgage]) and you do not meet any other exception or exclusion discussed later, include in your income the net amount of the canceled debt (the amount shown in box 2 minus the interest amount shown in box 3) [of Form 1099-C]."
In other words, mortgage interest that would otherwise be deductible if paid is *excluded* from COD income.
Conversely,
"If the interest would not be deductible (such as interest on a personal loan) and you do not meet any other exception or exclusion discussed later, include in your income the amount from Form 1099-C, box 2."
Therefore, I must conclude that as long as we are
That's the way I personally think it should be, I hope the legal appeal mentioned in the article I referenced succeeds.
-Mark Bole
Seems to me that the additional is claimed to be owed by the creditor, but who is to say it's actually owed? OP may be able to claim defenses that would wipe out the additional $3000.
Say for example someone walks across your lawn without your consent, or does some other minor act that you could conceivably complain about. You tell him that he violated your rights and he owes you $10,000. He tells you he's not going to pay a thing, and then you decide to drop the claim. Can you send him a 1099 for $10,000? Does he have cancellation of debt income of $10,000? I doubt it.
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