Discharge Of Debts: The Potential Unintended Consequences Of Issuing A Form 1099-C

In the typical bad debt situation, a financial institution will issue a Form 1099-C to the Internal Revenue Service ("IRS") and the borrower when a loan is written off. That administrative act is proving to be a new battleground with debtors who seek to find ways out of repaying their obligations. Most often, the issue arises where a lender forecloses on property, and in the process of charging off the loan, issues a Form1099-C while still attempting to recover a remaining deficiency balance. At the heart of the issue is the impact of the issuance of Forms 1099-A and 1099-C to the IRS. Form 1099-A is filed where a lender, in connection with a trade or business, and in full or partial satisfaction of a debt, acquires an interest in property that is security for that debt. See www.irs.gov/uac/About-Form-1099-A. Form 1099-C is filed for each debtor for whom more than $600 of debt is cancelled by an applicable financial entity and where an identifiable event has occurred. See, www.irs.gov/uac/About-Form-1099C. Where lenders have mistakenly issued a Form 1099-C and are still attempting to collect a deficiency balance following foreclosure, an emerging defense claimed by borrowers is that the indebtedness has been discharged.

The great weight of authority is that the mere issuance of a Form 1099-C does not serve to discharge a debt. Examples include:

FDIC v. Cashion, 720 F.3d 169, 176-81 (4th Cir. 2013) (Form 1099-C did not create issue of material fact as to whether debt had been canceled or assigned); Owens v. Commissioner of Internal Revenue, 2003 U.S. App. LEXIS 12481, 2003 WL 21196200, at *3 (5th Cir. May 15, 2003) (Form 1099-C was not evidence that creditor actually canceled debt, but at most reflected intention to cancel debt in the future); Capital One v. Massey, 2011 U.S. Dist. LEXIS 83817, 2011 WL 3299934, at *3 (S.D. Tex. Aug. 1, 2011) ("a 1099-C does not discharge debtors from liability" and "fact that [creditor] issued a 1099-C in relation to the borrowers' indebtedness is irrelevant and does not raise a genuine issue of material fact"); United States v. Reed, 2010 U.S. Dist. LEXIS 96079 2010 WL 3656001, at *2 (E.D. Tenn. 2010) (in absence of evidence "such as a surrender or cancellation of the note or a signed writing" by creditor, creditor was entitled to judgment as a matter of law); In re Sarno, 463 B.R. 163, 168 (Bankr. D. Mass. 2011); In re Zilka, 407 B R. 684, 689 (Bankr: W.D. Penn. 2009); Carrington Mortgage Services, Inc. v...