Final Rules Remove 3-Year Nonpayment Testing Period for COD Reporting

The IRS finalized a proposed rule issued in 2014 removing the three-year nonpayment testing period from the list of “events” for determining when debt had been discharged for purposes of issuing Form 1099-C, Cancellation of Debt, to taxpayers (T.D. 9793). The proposed regulations (REG-136676-13) were adopted without change, except the applicability date was changed.

The IRS changed the rule because it believed it confused taxpayers and did not increase compliance. 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 Forms 1099-C 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, creating a presumption that an identifiable event has occurred, 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.

Although creditors were required under the old rule to file Form 1099-C at the end of the 36-month period, it did not mean the debt had necessarily been canceled. As a result, the recipient of the form was often confused about whether he or she must report the amount as COD income if the debt had not actually been discharged.

The proposed regulations stated that the final regulations would be applicable to returns filed and payee statements furnished after the date the final regulations were published. However, the final regulations change the applicability date, making the regulations applicable to returns filed and payee statements furnished after Dec. 31, 2016.

—Sally P. Schreiber (sschreiber@aicpa.org) is a Tax Adviser senior editor.