IRS Removes 36-Month Test for Issuance of Forms 1099C by Lenders

The IRS has issued final regulations TD 9793 that eliminates the “36 month” non-payment testing period for certain lenders to issue Forms 1099C.  The IRS believes that this rule had created confusion regarding the proper reporting of cancellation of debt income.

A taxpayer has cancellation of debt income generally upon the occurrence of the first “identifiable event” where it is clear that the lender has no intention of attempting to enforce collection on the debt and the borrower has no intention to repay the debt. 

Under prior Reg. §1.6050P-1(b)(2)(iv) a 36-month rule was created that generally creates a rebuttable presumption that an identifiable event has occurred if a lender does not receive a payment during a 36-month testing period.  A lender can rebut that presumption if the lender has made bona fide collection efforts during the 12 month period ending as of the end of the calendar year in which the 36 month period ends or if facts and circumstances indicate that the debt has not been discharged.

The 36-month test was only of eight situations that are listed as identifiable events requiring the filing of a Form 1099C by the lender.  The other seven tests, which remain in place, are:

  • A discharge of indebtedness under the Bankruptcy Code;
  • A cancellation or extinguishment of an indebtedness that renders the debt unenforceable in a receivership, foreclosure, or similar proceeding in a federal or state court, as described in section 368(a)(3)(A)(ii) (other than a discharge under the Bankruptcy Code);
  • A cancellation or extinguishment of an indebtedness upon the expiration of the statute of limitations for collection (but only if, and only when, the debtor’s statute of limitations affirmative defense has been upheld in a final judgment or decision in a judicial proceeding, and the period for appealing it has expired) or upon the expiration of a statutory period for filing a claim or commencing a deficiency judgment proceeding;
  • A cancellation or extinguishment of an indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditor’s right to pursue collection of the indebtedness;
  • A cancellation or extinguishment of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding;
  • A discharge of indebtedness pursuant to an agreement between an applicable entity and a debtor to discharge indebtedness at less than full consideration;
  • A discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt;

The IRS notes that the seven that would remain are all objective events that are truly linked to an actual discharge of the debt, unlike the 36 month test.  As the preamble to the proposed regulations noted, this test was added to the regulations to replace a “facts and circumstances” test due to complaints by lenders that they wanted an objective test.

The regulations are effective for information returns required to be filed after December 31, 2016.  Therefore, a 2016 ending of a 36-month period with no activity will not trigger the need to file a Form 1099C for 2016.

While this rule was an information return only rule, the Tax Court had referred to it in certain cases regarding IRS attempts to assert cancellation of debt income where Forms 1099Cs were issued many years after the debtor stopped paying, finding actual discharge took place at the end of the 36-month period, and not at the later date the Form 1099C was issued.  For instance, see Clark v. Commissioner, TC Memo 2015-175.  Advisers will need to watch to see how the Tax Court reacts to the removal of this test when deciding the date when cancellation of debt took place.