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March 23, 2006

Credit cards are just too handy for some folks. It's too much for some people to walk past that new plasma TV when you can take it home just by pulling out your credit card. The new bankruptcy law makes it harder to walk away from credit card debt, so more debtors will be trying to work out compromises with their credit card companies. When they succeed in getting part of their balance forgiven, they'll find that the IRS will share in their success.

The tax law normally requires you to report income when your debts are forgiven. Creditors are required to report debt forgiveness on a form 1099-C, so the IRS computers are set to make sure you do report it. Henry Martins learned this unpleasant lesson in the Tax Court yesterday.

Mr. Martins, an engineer for Ford, moonlighted as an importer. He financed his imports on this American Express Card. When he ran into collection problems with his customers he got upside-down with AmEx, and they turned things over to a collection agency. In 2002 Mr. Martens cut a deal where he settled the $21,831.38 debt with a $15,000 payment.

Sure enough, AmEx issued a 1099-C for $6,831.38. Mr. Martins didn't count on sharing his debt relief with the tax man and he didn't report it on his 2002 Form 1040. The IRS computers noticed, and Mr. Martins ended up in Tax Court. He said that he had enough "membership rewards points" that he didn't really have debt forgiveness, that the delinquency fees shouldn't count, and that he never got the 1099-C. The judge disagreed:

Petitioner claims he did not receive a Form 1099-C from American Express discharging the debt. "The moment it becomes clear that a debt will never have to be paid, such debt must be viewed as having been discharged." The nonreceipt of a Form 1099 does not convert a taxable item to a nontaxable item.

The moral? When you cut a deal on your credit card debt, put aside something for the tax man. They don't go for for the "I didn't get the 1099-C" ploy.

The TaxProf Blog has more.

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