Editor: Michael D. Koppel, CPA/CITP/PFS, MSA, MBA
Practice & Procedures
Even with the economy starting to turn up a little, taxpayers and businesses are still defaulting on credit and loans. In this environment, tax advisers may consider whether their clients should issue a Form 1099-C, Cancellation of Debt, for a bad debt. A situation may arise where a client wants to ensure the forgiven debtor reports the income from the canceled obligation.
The Form 1099-C instructions identify who must issue the form. The list includes financial institutions, credit unions, and organizations whose significant trade or business is the lending of money. Can someone other than the above issue a Form 1099-C for an uncollectible amount? This item considers this question as well as other Form 1099-C issues.
IRS Service Center Advice (SCA) 1998-020 addressed whether “an individual or entity not required to file a Form 1099-C under Section 6050P of the Internal Revenue Code [may] nevertheless voluntarily file the form.” SCA 1998-020 discusses Sec. 6050P, what information needs to be filed with the Form 1099-C, and what constitutes an identifiable event. The memorandum states that,
While the requirement to report discharges of indebtedness applies only to the entities described above, there is no specific prohibition in the Internal Revenue Code or the Income Tax Regulations that forbids the reporting of discharges of indebtedness by entities not required to report. Such reporting may encourage voluntary tax compliance and proper gross income inclusions.
The timing of the filing of the Form 1099-C for entities who are not required to file is important as well. SCA 1998-020 cautions that an entity that is not required to report should not issue a Form 1099-C unless there is either a discharge of indebtedness or a specific identifiable event described in the regulations. The memo states that the collection of a debt after filing a Form 1099-C “ought to occur very infrequently.”
Filing a Form 1099-C by a vendor is straightforward. If a debt of more than $600 is canceled and an identifiable event occurs, the vendor then issues a Form 1099-C. What happens when an employer forgives a debt from an employee? How about an independent contractor? If an entity discharges a debt of a person who is the entity’s employee, any income from the debt cancellation that is compensation, if it totals more than $600, must be reported on the employee’s Form W-2, Wage and Tax Statement (Regs. Sec. 1.6041-2(a)(1)). Withholding and payroll taxes are issues as well when an employer cancels an employee’s debt. If the person whose debt is discharged is not an employee of the applicable entity, but the debt discharge is nonetheless compensation for services, the compensation should be reported on a Form 1099-MISC, Miscellaneous Income (because under these circumstances, it is compensation, not cancellation of debt income; cancellation of debt income should not be reported on Form 1099-MISC.)
Entities not required by Sec. 6050P to file Form 1099-C may nevertheless voluntarily file the form in appropriate circumstances. The creditor should make sure a specific identifiable event has occurred to warrant the issuance of a Form 1099-C. Debt forgiveness of employees and independent contractors have different reporting requirements. It is important to understand these concepts when contemplating whether to issue a Form 1099-C.
Michael Koppel is with Gray, Gray & Gray LLP in Westwood, Mass.
For additional information about these items, contact Mr. Koppel at 781-407-0300 or email@example.com.
Unless otherwise noted, contributors are members of or associated with CPAmerica International.