The IRS Office of Professional Responsibility has issued Alerts from the Office Professional Responsibility Issue 2015-02 that discusses the implications of a preparer using Form 1099C as a “collection tool” to encourage clients to pay the balances due to the professional.
The alert specifically avoids giving a direct answer on whether the proposed conduct violates federal law and/or provisions of Circular 230, but certainly raises areas of concern.
The issue in presented as a question involving a specific fact pattern, followed by a discussion of the issue suggesting potential problems.
The facts are described as follows:
Q: What are the Circular 230 implications, if any, for a Tax Professional who, as an alternative to pursuing collection of an earned fee from a client, files with the IRS a Form 1099-C, Cancellation of Debt, reporting the amount of the client’s unpaid bill as a discharged debt?
My firm and I want to use Forms 1099-C, as a collection technique with delinquent/non-paying clients. I am a tax professional subject to Circular 230. I own and operate a small firm that provides various tax representation services for compensation. My firm usually enters into a written fee agreement with a client for the services agreed upon. For most clients, the firm does not require a retainer or the payment of fees in advance. The firm generally bills clients for the services after the fact, requesting payment within 30 days. Invoices unpaid after 30 days are considered delinquent and treated as subject to collection regardless of whether the client disputes the liability.
We periodically write-off balance-due amounts as uncollectible based on established criteria. As to amounts treated as non-collectible, the firm would like to complete and file Forms 1099-C identifying each such client as the “debtor” and reporting the unpaid account balance as the “amount of debt discharged” in box 2 of the form. The firm would simultaneously send Copy B of the form to the client for purposes of reporting the discharged amount on the client’s income tax return(s). The goal would be to encourage the client to pay, or make him/her report additional income for our “free” services. I am unsure as to whether this business practice is consistent with my obligations under Circular 230.
The notice starts by warning that a tax professional is under an obligation to understand the proper federal and/or state law that applies to his/her conduct. As well, the notice states that “If a tax professional repeatedly uses Forms 1099-C, as a business strategy to collect unpaid fees, when the tax professional knows, or should know, that the facts and circumstances do not provide a basis for doing so, the conduct calls into question the tax professional’s fitness to practice before the IRS. A pattern of issuing Form 1099-C with a reckless disregard as to the existence of a debt (because, for example, the former client does not have a fixed contractual liability to repay a sum previously received), or the absence of an “identifiable event” triggering a reporting requirement, is inconsistent with the standards of competency and professionalism embodied in the rules of practice.”
The notice goes on to describe particular issues in the United States Code and the regulations we know as Circular 230 that may relate to the conduct of the practitioner in this area:
A number of provisions concern responsibilities in connection with client communications. Section 330(b)(4) (Title 31), for example, allows for discipline, after notice and proceeding, for a representative who, with intent to defraud, willfully and knowingly misleads or threatens the person being represented or a prospective person to be represented. Several provisions of Circular 230 also are relevant, and should be kept in mind. Section 10.22(a) of Circular 230 requires a tax professional to exercise due diligence in (1) preparing and filing returns, documents, and other papers relating to IRS matters, (2) determining the correctness of oral or written representations made by the tax professional to the IRS, and (3) determining the correctness of oral or written representations made to clients. Section 10.35 requires tax professionals to “possess the necessary competence to engage in practice” before the IRS. To be competent, a tax professional must have the “appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged.” Section 10.51(a)(4) identifies as “incompetence and disreputable conduct,” the giving of false or misleading information “to the Department of the Treasury or any officer or employee thereof.”
The notice immediately disclaims any implication that such conduct would automatically be in violation of the above provisions (though clearly it’s difficult to avoid the implication that it’s very possible such might have occured—otherwise a reader would wonder about the point of both issuing this notice and outlining those provisions.
The alert goes on to describe the law dealing with cancellation of debt and the Form 1099C in general. The notice provides:
As a matter of tax law, a discharge of indebtedness is generally gross income of the debtor, pursuant to section 61(a)(12) of the Internal Revenue Code (and Treasury Regulation section 1.61-12(a)). Certain discharges of indebtedness are excluded from gross income (see Code section 108). Whether there has been a discharge of debt that must be treated as income to a taxpayer, and the tax year in which the income is realized, are questions of fact. See Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). Whether there is a debt that can be discharged is also a question of fact, as it “generally occurs when a taxpayer receives funds that are not includible in income, because the taxpayer is obligated to repay the obligation at a later date.” Merten’s Law of Federal Income Taxation, Vol. 2, § 11:6 (Jan. 2014) (Emphasis added).
Code section 6050P, which establishes the requirement to file an information return reporting a discharge of debt (Form 1099-C), is directed only at “applicable entities” and excludes from such reporting any discharge below $600. An “applicable entity” is defined as an “executive, judicial, or legislative agency” of the United States or an “applicable financial entity,” such as a bank, savings and loan association, credit union, the FDIC, or “any organization a significant trade or business of which is the lending of money” (§ 6050P(c)).
The memo concludes on the following cautionary note:
It is difficult to conceive of a situation in which a tax professional, principally engaged in providing tax services will be an “applicable entity” justifying the use of Form 1099-C to attribute income to an arguably scofflaw client for the nonpayment. However, every case will depend on its own particular facts and circumstances, including the existence (or not) of “debt,” with the crux of the analysis turning on whether the client can be said to have received previously untaxed funds from an applicable entity for which there is an obligation for repayment.
So what is a practitioner to make of this notice and conclusion. It seems clear from the concluding paragraph that the OPR considers that in most situations a practitioner would not be justified in issuing a Form 1099C, certainly if the only reason to do so is to “get paid” by the client and/or “punish” the client by having the client report taxable income.
Of course, in this author’s view even if such a filing is not “wrong” per se, it’s difficult to see a positive outcome for the CPA who filed a form when not required to do so if word got out to other clients that the CPA “turned in” a former client. While clients who skip out on their agreement to pay are frustrating, it’s not clear that the positives of this technique (which seem, at best, to be a short term “feel good” from extracting revenge) could ever overcome the negatives from the impact on current clients and potential future clients once word of this action becomes known.