Removing the Non-Payment Testing Period Should Provide Clarity to Borrowers, Banks, Credit Unions and Other Financial Institutions

On October 15, 2014, the Internal Revenue Service (IRS) and the Department of the Treasury proposed to remove the deemed 36-month non-payment testing period from the list of identifiable events that trigger the requirement to report cancelation of debt (COD) income by banks and other financial institutions. The IRS published proposed amendments to Treasury regulations under Internal Revenue Code § 6050P, Prop. Treas. Reg. § 1.6050P-1.

Current law requires that any applicable entity that discharges, in whole or in part, the debt of any person of $600 or more file an information return on Form 1099-C with the IRS and provide a copy of the return to the person with respect to whom such report is being filed. See I.R.C. § 6050P; Treas. Reg. § 1.6050P-1(a).

Debt is considered discharged upon the occurrence of a certain event (an “identifiable event”), such as bankruptcy, foreclosure, probate, or an agreement between a creditor and a debtor to discharge debt. The Treasury Regulation currently lists eight identifiable events that indicate discharge of indebtedness. Id. While seven of the eight identifiable events refer to specific occurrences of an actual discharge, only one event sets forth a rule that is not directly related to a specific occurrence of the discharge, but instead creates a rebuttable presumption of a deemed discharge of debt, nevertheless triggering the statute’s information reporting requirements. See preamble to proposed treasury regulation.

Pursuant to the Treas. Reg. § 1.6050P-1(b), an identifiable event will be deemed to have occurred if a creditor does not receive payments within 36 months, which period may be increased in some cases by the number of months within which the creditor attempted to collect the debt (the “non-payment testing period”).

Whether or not an actual discharge of indebtedness occurs, financial institutions affected by this rule are required to report COD income on Form 1099-C upon the expiration of the non-payment testing period. This rule gives rise to a disparity between the time COD income is reported and an actual occurrence of the discharge of debt. This not only interferes with the IRS’s collection efforts, but has also caused confusion among creditors and debtors with regard to the requirement to include COD income in gross income, subsequent collection or discharge of debt and the need to file amended returns.

The proposed amendments to the Treasury regulation remove the non-payment testing period from the list of identifiable events. Therefore, financial institutions subject to the reporting requirements will no longer be required to file Form 1099-C simply due to the debtors’ not making debt payments upon the expiration of 36 months from the date the debt has been outstanding. This change in the reporting requirement of COD income should provide some relief to banks, credit unions and other financial institutions subject to the reporting requirements of IRC § 6050P as well as to the debtors from whom debt payments were not received pursuant to the non-payment testing period.

The notice of proposed rulemaking did not provide for an effective date. The new law will be effective on the date the amended final Treasury regulations are published in the Federal Register.