“Dear Paula,

I received a 1099-c form with a cover letter saying they will report default payday loan as ordinary income and that they officially had forwarded the 1099-c form to the IRS. It tells me a settlement agreement. I called them and the guy told me if I didn’t want the IRS to get the 1099-C Form to pay the settlement. I’m wondering if it’s a scam because he also gave me directions to pay through Bank of America and he gave me a P.O. Box address in Texas to send it to.”


Julia – Complicated question! Without seeing the actual cover letter (and what fine print they have put at the bottom), there are a few red flags that come up for me. A 1099-C is issued by a creditor or collector when you have already settled a debt.

I think the issue that trips everyone up here is that there are two issues. One is an accounting function which triggers a tax issue and the other one is the debt.

Back in the 80s after the S&L crisis the banks were required to report bad debts on their books rather than show inflated balances of non-performing debt. The charge off occurs after 180 days delinquent. Once the mandatory charge off went into force that triggered the IRS 1099-C reporting.

Now, if you are insolvent, you can be exempt from paying any tax due with IRS Form 982.

That accounting/tax event has nothing to do with the legal sale and collection of a valid debt.

I know it sounds crazy but since the 1980s that’s the way it works.

The amount on the 1099-C is the amount of the debt that is “forgiven” or that you aren’t paying. Let’s say your payday loan was for $500 and they settled for $300. The $200 you DIDN’T pay is what they can issue a 1099-C for. (Most creditors don’t issue a 1099-C unless the forgiven debt is $600 or more.) If you HAVEN’T settled a debt, then the creditor/collection company CANNOT be issuing you a valid 1099-C form and is trying to intimidate you or they are trying to get you to pay on a debt whose statute of limitations have expired. They want to force you to settle with them. Just because they discharge a debt doesn’t mean that the have settled it or that you have created income for yourself in the process. ONLY the ORIGINAL creditor can issue a 1099-C. If the creditor listed on the 1099-C is NOT the original company where you took out the payday loans, then you will want to send a copy of the letter and 1099-C form to your state’s Attorney General’s office as well as the Attorney General’s office for the state where the collection agency resides. 

If it IS from the actual creditor, or is listed that way on the 1099-C, this whole scenario gives you several options. How much income tax you MIGHT have to pay would depend on whether you qualify for “insolvency” based on IRS Form 982. If you review that form, you may find that you would actually owe NO income on that forgiven $200 or whatever amount it is for you. If you don’t qualify to have the 1099-C tax liability wiped out, then depending on your tax bracket, you’d have to pay taxes on it. But let’s look at what that means. If it’s $200 worth of forgiven debt, and you’re in the 28% tax bracket like most folks, then you’d be paying an additional $56 in taxes on the amount forgiven. So you have to decide what you want to do based on that.

You can ignore them.

You can write and tell them to cease all contact with you.

You can file the 1099-C with your taxes and write the creditor a thank you note letting them know that you have filed the 1099-C with the IRS and that you appreciate their forgiveness of your debt and that you expect your credit reports to be updated to reflect that this debt was settled and that they will cease and desist any future attempts to collect this debt. Given that there was no settlement at all, and they “forgave” the amount, $56 in taxes would be a small price to pay to make a $56 debt go away forever. Basically calling THEIR bluff and getting rid of the debt for good.

You could copy the 1099-C and their letter, and send it to the Federal Trade Commission for violation of the Fair Debt Collection Practices Act (FDCPA). I’d also recommend sending the IRS a complaint as well. It’s considered tax fraud to knowingly submit a “false or altered document” – and since they have stated in their letter that they have “officially forwarded the 1099-C form to the IRS”, in your knowledge they have actually done so. You can submit your complaint to the IRS using Form 3949-A. (Send everything out certified mail, return receipt requested.) 

If the last time you made a payment on the debt was 7 years ago, then the statute of limitations on the debt may have run out; in which case they cannot legally submit a 1099-C or collect on the debt.

Hope that helps!

Peace and prosperity,
Paula Langguth Ryan

*Original article courtesy of Steve Rhode, Get Out of Debt Guy