Tuesday, August 25, 2009
Bankruptcy Court Finds Discharge of Indebtedness by Issuance of 1099-C Forms Does Not Equate to Discharge of Debt
By: Brett Henson
For homeowners considering a short sale or deed in lieu of foreclosure ("DIL") as a means to prevent foreclosure, a recent bankruptcy decision from the Third Circuit has important implications towards the treatment of deficiency liability. In re Zilka, a July 2009 case from Pennsylvania, the debtor received a post-petition personal injury settlement allowing for settlement of all creditors claims in the bankruptcy estate. At issue was whether a creditor could file a claim against the debtor for accounts it had previously charged off and issued 1099-C forms for cancellation of debt to the IRS. The debtor argued the charged off accounts and the 1099-C forms amounted to a discharge of the debts. However, the court distinguished between a charge off of indebtedness and a discharge of indebtedness. The court found the IRS requirement that a lender file a 1099-C form to be a reporting requirement for income tax purposes. In contrast, it held state law governs whether a discharge of debt has occurred. As such, a creditor may still attempt to collect on a charged off debt during bankruptcy proceedings, even if it has previously issued 1099-C forms.
The ruling in Zilka highlights the importance of tax considerations for homeowners who complete a short sale or DIL. Banks must issue a 1099-C anytime there is a deficiency resulting from the sale of a property. For instance, a homeowner, Bill, owns two properties: property 1 is his primary residence and property 2 is an investment property he rents to tenants. For the purposes of the example, Bill considers property 2 a bad investment because the mortgage balance is $45,000.00 greater than the value of the property, and he is unable to find tenants. He obtains a short sale offer of $20,000.00 less than the value of the property, which the bank is willing to accept. Should the sale close, the IRS requires the bank to report a deficiency of $65,000.00 (Mortgage balance of $45,000.00 + $20,000.00 less the value of the property) to by filing a 1099-C form. When Bill completes yearly tax returns, he would be required to report the $65,000.00 as gross income, which, after deductions and exemptions, would increase his taxable income, and potentially place him in a higher tax bracket. The ruling in Zilka, though, would allow for Bill to re-adjust his income if the bank later filed a claim in bankruptcy court for the deficiency of $65,000.00. In short, Zilka affirms the principal that a debtor may be liable for deficiencies by either an increase in the debtor's taxable income or the creditor's right to collect on the deficiency, but not both.
There are a few applicable exemptions under the Internal Revenue Code for tax liability resulting from deficiencies in debt settlement. For instance, deficiencies resulting from the sale of a qualified principle residence are exempt from gross taxable income in most circumstances. In the example above, the QPR exemption would apply if Bill can show he has lived in the property for 2 years, the debt was used to acquire, construct, or substantially improve the property, and the total debt is less than $2 million. Although this exemption excludes deficiency income reported through a 1099-C from Bill's gross income, it also increases his tax basis if there is a short sale of the property. However, the insolvency exemption, which applies if Bill's total liabilities exceed his assets, would operate to cancel any liability resulting from this increased basis.
Wednesday, August 12, 2009
A Guide to Federal & State Restraints on Consumer Debt Collection
By: Paul Silvestri
Many of us are often victimized by unscrupulous businesses attempting to collect debt using intimidating guerilla tactics. Few really know the different consumer protection statutes which exist to protect the public from these unethical and sometimes even threatening business practices. 15 U.S.C. §1692, et sequi known as The Fair Debt Collection Practices Act (“FDCPA”) is the federal law which promotes ethical business practices by debt collectors. The Florida counterpart is Fla. Stat. §559.55, et sequi, more commonly known as The Florida Consumer Collection Practices Act, (FCCPA). These acts establish general standards of prohibited conduct, define and restrict abusive collection acts, and provide specific rights for consumers.
As a result of the rise of information technology, debt collectors have become increasingly sophisticated and deceptive in their practices. Therefore, it is necessary for consumer’s to know their rights.
Validation Rights Concerning Debt
General Notification: Within 5 days after the initial communication from the consumer in connection with the collection of any debt, a debt collector shall, unless the following information contained in the initial communication or the consumer has paid the debt, send the consumer written notice containing – 1) the amount of debt; 2) the name of the creditor to whom the debt is owed; 3) a statement that the consumer has 30 days to contest the validity of the debt and if they fail to do so the debt will be assumed to be valid; 4) A statement that after the consumer contests the validity, the debt collector must produce verification of the debt or a copy of the judgment against the consumer to be delivered to the consumer.
Request for Validation: If consumer disputes the debt within the 30 day window, the collector shall cease collection of the debt until the debt collector verifies the debt to the consumer and provides the name and address of the original creditor.
Representations Concerning Amount of Debt
The FDCPA is violated when any communication is sent to the consumer which does not completely disclose the full amount of the debt. 15 U.S.C. §1692g. Even a statements such as “this amount does not include accrued but unpaid interest, or unpaid late charges” has been held in violation.
False Threats of Lawsuits
The FDCPA contains a general proscription against the use of any false, deceptive or misleading representation or means in connection with the collection of nay debt. 15 U.S.C. §1692e. The misrepresentation or exaggeration of the imminence of a suit on intent or authority to sue constitutes a violation of the FDCPA.
Communication With Third Parties
A debt Collector, with limited exceptions or to effectuate post-judgment judicial remedy, may not communicate in connection with the collection of any consumer debt, with any person other than the consumer, his attorney, a consumer reporting agency, a creditor, the attorney of the creditor, or the attorney of the debt collector.