Proposed Regs. Would Eliminate 36-Month Testing Period from COD Reporting Requirements

Because the IRS believes that requiring the filing of Form 1099-C, Cancellation of Debt, at the expiration of a 36-month nonpayment of debt testing period “creates confusion for taxpayers” and does not increase tax compliance, the Service released proposed regulations to eliminate the rule (REG-136676-13).

Under Sec. 6050P and its regulations, cancellation-of-debt (COD) income of $600 or more must be reported on Form 1099-C when any of eight identifiable events occur. Seven of these events are specific instances that actually result in a discharge of debt, such as an agreement between the creditor and debtor. The eighth, the expiration of the nonpayment testing period, does not actually result from a discharge and may be difficult to determine. It may also be confusing to debtors who receive these forms and do not know whether to report the amount in income.

The nonpayment testing period is a 36-month period during which a creditor has not received any payments from the debtor, which creates a presumption that the loan was discharged, thus triggering the Form 1099-C filing requirement. The creditor can rebut this presumption by showing significant, bona fide collection activity or other facts and circumstances that indicate the debt has not been discharged.

The nonpayment testing period was added to the regulations in 1996 in response to creditors’ concerns that the prior facts-and-circumstances test for determining when an identifiable event had occurred was not sufficiently clear to allow them to determine when reporting was required. Commenters requested that reporting be required after a fixed period during which no collection efforts have been made. The result was the 36-month nonpayment testing period.

However, the IRS has determined that, although creditors must file Form 1099-C at the end of the 36-month period, it does not mean the debt has necessarily been canceled. As a result, the recipient of the form is often confused about whether he or she must report the amount as COD income if the debt has not actually been discharged.

In 2012, the IRS asked for comments about whether the rule should be retained (Notice 2012-65). All the comments that were received recommended that the rule be removed or revised. In response, the proposed regulations will remove Regs. Secs. 1.6050P-1(b)(2)(i)(H), (b)(2)(iv), and (b)(2)(v) (the nonpayment testing period), effective on the date the regulations are published as final in the Federal Register.