IRS Finalizes Regs. on Reporting for Discharges of Indebtedness

Editor: David J. Kautter, CPA

The IRS has issued final regulations (T.D. 9461) on information returns for cancellation of indebtedness by certain entities under Sec. 6050P. The final regulations, which were effective September 17, 2009, adopt 2008 proposed regulations without substantive change.

The final regulations limit application of the 36-month, nonpayment testing period (one of eight identifiable events triggering the Form 1099-C, Cancellation of Debt, information reporting requirements) to “applicable financial entities.” These include financial institutions, credit unions, and certain of their federally supervised affiliates, as well as the Federal Deposit Insurance Corporation, the Resolution Trust Corporation, the National Credit Union Administration, and other specified federal executive agencies. This group has been required to report cancellations of debt since Sec. 6050P was initially enacted in 1993. Other lenders that were later added and made subject to the Form 1099-C reporting requirements are no longer required to report when the 36- month nonpayment period is met.

Background

Sec. 6050P generally requires certain entities to file information returns with the IRS and to furnish information statements to debtors, reporting discharges of indebtedness of $600 or more.

Regulations issued in 1996 required applicable financial entities, as then defined in Sec. 6050P, to issue Form 1099-C on the occurrence of any one of eight “identifiable events” listed in the regulation. One of those identifiable events involves the expiration of a “non-payment testing period,” creating a presumption, absent a showing of significant, bona fide collection activity, that the loan was discharged, thus triggering the filing of a Form 1099-C when a creditor had not received a payment from the debtor for 36 months (the 36-month rule).

Following the issuance of the 1996 regulations, the Debt Collection Improvement Act of 1996, P.L. 104-134, subsequently expanded the scope of eligible persons required to file Form 1099-C to include any executive, judicial, or legislative agency. The Ticket to Work and Work Incentives Improvement Act of 1999, P.L. 106-170, further expanded the category of persons subject to the reporting requirements by expanding the definition of applicable financial entity to include “any organization a significant trade or business of which is the lending of money.”

In 2008, temporary and proposed regulations (T.D. 9430; REG-118327-08) were issued limiting application of the 36- month nonpayment testing period rule of Sec. 6050P to applicable financial entities as defined in the Omnibus Budget Reconciliation Act of 1993, P.L. 103-66. This change, effective November 10, 2008, limited application of the rule to financial institutions, credit unions, their government- supervised affiliates, and certain federal executive agencies. The text of the temporary regulations also served as the text of the proposed regulations, which requested comments.

The IRS received a single comment agreeing with the proposed regulations but requesting additional guidance on various other areas addressed in the existing regulations under Sec. 6050P. Though the IRS viewed the comments as outside the scope of the proposed regulations, it stated that it will consider the issues raised in connection with future guidance under Sec. 6050P.

Final Regs.

The final regulations limit the application of the 36-month nonpayment testing provisions as a triggering event for filing Forms 1099-C to the group of applicable financial entities specified in the originally passed Sec. 6050P legislation (financial institutions, credit unions, their governmentsupervised affiliates, and certain federal executive agencies). Thus, they remove from the 36-month nonpayment testing provision the two groups that had been added in subsequently enacted amendments to the original legislation.

By limiting the application of this triggering event, Treasury believes that premature information reporting of cancellation of indebtedness income will be avoided, thus reducing the burden on certain lenders and protecting debtors from receiving information returns that prematurely report cancellation of indebtedness income. However, taxpayers and practitioners should note that the nonpayment testing provision constitutes only one of eight identifiable events that trigger the requirement to file Form 1099-C. All lenders required to furnish Forms 1099-C continue to be required to report upon the occurrence of any of the other seven identifiable events.

Implications

Given the fact that the application of the 36-month rule is among the most challenging, and subjective, of the criteria for triggering the filing of Forms 1099-C, this change comes as good news for affected filers. However, taxpayers must keep in mind that they continue to be required to report cancellation of debt upon the occurrence of any of the other seven identifiable events.

EditorNotes

David Kautter retired from Ernst & Young LLP in Washington, DC, in December 2009.

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.

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