The IRS has issued final regulations (TD 9793) removing the "36-month non-payment testing period" applicable to a deemed discharge of indebtedness for which a lender must file Form 1099-C, Cancellation of Debt. The 36-month non-payment rule, as set forth in Reg. Section 1.6050P-1(b)(2)(iv), established a rebuttable presumption that an identifiable event has occurred, resulting in a requirement to file a Form 1099-C, if a creditor does not receive payment on a loan within a 36-month testing period. Treasury and the IRS removed this requirement because it created some level of confusion and did not increase tax compliance for debtors or provide the IRS with valuable third-party information that may be used to ensure taxpayer compliance. Specifically, the reporting of debt discharge under the 36-month testing period did not, in fact, mean that borrowers had taxable income to be recognized on their income tax return.

Background

Income from the discharge of indebtedness is includable in gross income under Section 62(a)(12). Section 6050P, added to the Code in 1993, originally required certain financial institutions, credit unions and federal executive agencies to file information returns with the IRS if they discharged indebtedness of $600 or more during a calendar year. Changes in the tax law in 1996 expanded the reporting requirement of Section 6050P to include any executive, judicial, or legislative agency, and, in 1999, to include any organization for which the lending of money is a "significant trade or business."

Temporary regulations under Section 6050P, issued in 1993, provided that an applicable entity's reporting responsibility would be triggered by "an identifiable event" indicating that, based on all the facts and circumstances, the debt would never have to be repaid. Three examples were listed: 1) a discharge of indebtedness in bankruptcy; 2) an enforceable agreement between the applicable financial entity and the debtor to discharge the debt, and 3) a cancellation or extinguishment of the debt by operation of law. The IRS and Treasury issued final regulations (TD 8654) under Section 6050P in January 1996.

In response to public comments, the 1996 final regulations did not adopt the facts-and-circumstances test for determining that a debt was never going to be repaid, but rather provided a list of eight identifiable events upon which reporting is required:

1. Discharge of a debt in bankruptcy

2. Cancellation or extinguishment of a debt rendering it unenforceable in a receivership, foreclosure, or similar proceeding in federal or state court

3. Cancellation or extinguishment of a debt due to expiration of the statute of limitations for collection or the statutory period for filing a claim or commencing a deficiency judgment proceeding

4. Cancellation or extinguishment of a debt due to the creditor's election to foreclose remedies, which statutorily terminates the creditor's right to pursue collections

5. Cancellation or extinguishment of a debt due to probate or a similar proceeding

6. Discharge of a debt under an agreement between the applicable entity and the debtor for less than full consideration

7. Discharge of a debt because the creditor has decided not to pursue collection or has a policy against pursuing collection

8. Expiration of a 36-month non-payment testing period

The 36-month rule created a rebuttable presumption that an identifiable event was deemed to have occurred if the creditor did not receive a payment on a debt for 36 months, and could be rebutted if the creditor had engaged in significant collection efforts within 12 months.

Temporary and final regulations (TD 9430) issued in November 2008 exempted from the 36-month rule entities subject to reporting because a significant portion of their trade or business was the lending of money.

The IRS proposed the elimination of the 36-month non-payment rule in regulations issued in 2014 (REG-136676-13). The IRS received four comments on the proposed change, all of whom agreed that the 36-month rule should be eliminated.

Applicability date

Under Section 6050P, Forms 1099-C must be filed on or before February 28 (March 31 if filed electronically) of the year following the calendar year in which the identifiable event occurs and payee statements must be furnished on or before January 31 of the year following the calendar year in which the identifiable event occurs. Lenders will not be required to report amounts under the expiration of the 36-month testing period on Forms 1099-C required to be filed after December 31, 2016.

Implications

The 36-month non-payment testing period created confusion for many debtors. However, it was originally added to the regulations at the request of lenders to provide an identifiable event that could be easily tracked for reporting purposes. Now lenders will need to focus on the remaining seven identifiable events; in particular, they will need to be sure they determine when a discharge of a debt occurs because the lender has "decided not to pursue collection or has a policy against pursuing collection" to ensure compliance with Section 6050P.

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