For a business owner who has fallen behind on a loan, the words “charged off” and “1099-C” tend to blur together. Both seem to say the lender has given up. Neither one, as it turns out, means the loan has been forgiven. The term “charge-off” refers to an accounting practice on the lender’s part. It means that, for internal accounting purposes, the lender has declared the loan uncollectable. The term “1099-C” refers to a tax form, and a lender has to send it when one of the “identifiable events” in Treasury Regulation 26 CFR 1.6050P-1 has happened. So the two terms don’t mean the same thing. One is a bookkeeping entry. The other is a report to the IRS.
Identifiable Event
As the IRS sees it, a debt is discharged once it is clear the money is never coming back. When it is cancelled (discharged), it is taxable income to the borrower. How do you know when that point arrives? That depends on the specific facts, and often on whether the creditor had the specific intent to discharge the debt, coupled with an objectively identified event. The regulation lists eight such events. In plain terms, an event happens when the debtor goes bankrupt, or the statute of limitations runs out on collection, or a receivership, foreclosure or similar proceeding cancels the debt and leaves it unenforceable, or the creditor elects a foreclosure remedy that statutorily bars a claim, or the debt is cancelled in probate. Or the creditor discharges it pursuant to an agreement. Or the creditor makes a decision, or has a defined policy that would cause them to stop collecting debt and discharge it. Or if a nonpayment testing period expires in specific types of cases. And the existence of an identifiable event is presumed when the lender has not received a payment for 36 months. And if the discharge happened before some identifiable event, then the lender can either report it on a 1099-C or not - their choice. Notice what is not on the list: a lender simply writing the loan off its own books. They are taking a bookkeeping loss. That is not the end of the line, for them. The closest item is the seventh, and it takes a decision or policy to stop collecting and to discharge the debt. So it’s not hard to imagine why a lender might write off a loan (or will at least consider writing it off) and not issue a 1099-C.
So the two are not mutually exclusive. A loan can be charged off and then result in a 1099-C. Maybe the lender charged off the debt, then made a decision that it would discharge the debt. That is the seventh event, and a 1099-C follows. Or maybe it let a statute of limitations run on the loan. But what if a lender charged off a loan and then never followed up on it? If no payments come in for 36 months, the regulation presumes an event anyway, so the form can arrive long after the charge off. What all of this means is that charging off the debt and sending a 1099-C are two different things.
A 1099-C Doesn’t Mean That the Debt Is Forgiven
Now the question most owners actually care about. If a 1099-C shows up, is the debt gone? The IRS says no. A 1099-C doesn’t mean that the debt is forgiven because the IRS doesn’t take it as a creditor’s acknowledgement that the debt is discharged. It is just a way of reporting that an event has occurred for tax purposes. On top of that, it is possible that the issuer just wrote a mistake and can correct it using an amended form.
Most judges have gone along with that. In In re Zilka, a 2009 case, and others like it, many courts have decided that just because the bank issues a 1099-C, that doesn’t mean the debt was canceled. Then came In re Reed in 2013, where a bankruptcy court decided that it was not reasonable, and not entitled to deference, for the IRS to hold that view if the debtor had actually relied on the 1099-C and included the cancelled debt in gross income. Reed did not say the form wipes out the debt by itself. It said it can be an admission that the debt has been discharged. And it would be unfair to make the debtor report it as income and still allow the creditor to collect it. Even that win had limits: in Reed, the court only barred collection of the principal, and the lender only had to report the principal. But there were a bunch of other things accrued that weren’t collected, and weren’t cancelled, like interest, collection costs, and attorneys’ fees, and all of that. And the thing is, those things are still due and collectable. And for now, most courts will likely continue to follow the majority view and still allow collection after the issuance of a 1099-C.
The Loan Is Still Yours
So where does all of this leave you if your loan has been charged off, or if a 1099-C has already shown up in the mail? The first thing to understand is that whatever internal accounting entry your lender has made, the loan is still yours. The lender isn’t making anything but a bookkeeping entry, a tax filing, or a possible mistake. It hasn’t thrown in the towel yet. The second thing to understand is that the Reed case turned on what the borrower did with the form. The borrower treated it as if it were a cancellation of debt, and actually included the debt as income on the tax form. A court could follow Reed when a business has done the same. Even then, be aware the lender might be collecting on the “other stuff” that it didn’t cancel and so didn’t have to report. And most courts probably won’t follow it at all.
Lenders have noticed Reed too. The advice they are getting is to write a clear policy on when they issue a 1099-C, to line that up with events like foreclosure and the running of the statute of limitations. They are also told to send the form on time and to make sure to spell out that the form isn’t an admission that the debt has been forgiven, only that it is being filed to comply with IRS rules.
So, is a charge off the same as cancellation of debt on a 1099-C? No. And for a business owner who is trying to get out from under a loan, that means the end isn’t necessarily near. A charge off is the lender’s own accounting. A 1099-C is a tax report tied to an identifiable event, and in most courts even that report does not stop collection. When either one lands on your desk, the first thing to do is to determine what the lender has actually done and what the consequences are. For a business owner, it may mean that further negotiations with the lender might be in order, but at the least it means the loan isn’t gone yet. For anyone with an overdue loan, it’s a good idea to investigate the bank’s policies, to review your own tax treatment, and to talk with an attorney before doing anything. Don’t count your chickens before they hatch, and when the 1099-C does come, understand you still have a debt.
