The intensity of study for CPA exam success is aimed at assuring accountants are capable of applying the same effort to future work endeavors. This is most clear in cases involving income tax matters. A general familiarity with various tax circumstances is often insufficient for accurate reporting of income and deductions. Tax accountants must possess an understanding of every vital element to any tax issue.
The devil is in the details, as the old expression goes. That is certainly revealed in Tax Court decisions. As an example, the Court ruled in May 2012 on a case that involved a small but important detail regarding the tax consequences of a bad debt. The tax impact of a non-collectible loan entails knowing a few factors from CPA review class.
Each of the conditions for a lender deducting bad debt is crucial. One of the elements is establishing exactly when a loan becomes worthless. That identifies the year in which the lender takes a tax deduction for a bad debt. This also triggers a report of income for the borrower in the same year, unless the lender continues collection efforts.
Examination of the tax features about a bad debt is readily available in online CPA review. An identifiable event fixes the date of worthlessness for a debt. One such occurrence arises when a lender has not received payment from a borrower for 36 consecutive months.
A taxpayer named David Stewart recently used these rules to his advantage in Tax Court. Stewart incurred substantial credit card debt to MBNA in the early 1990s. By 1996, he had stopped making payments and MBNA charged off the debt in 1996.
A debt collection company purchased Stewart’s debt from MBNA and then sold it in 2007 to a second collection company. The new debt holder contacted Stewart for payment until he reminded the collector that the statute of limitations for collection of the debt had expired. Upon closing the books on Stewart’s debt, the collection company issued a Form 1099-C. This form is familiar in CPA preparation courses. It identifies borrowed funds that comprise income because of failure to repay.
The IRS claimed back taxes on Stewart for his omission of the 1099-C amount on his 2008 tax return. Stewart argued – and the Tax Court agreed – that 2008 is not the correct year of debt forgiveness. The lack of any payment after 1996 causes recognition of 1999 as the year of an identifiable loss event because 36 months of nonpayment had elapsed. To overcome setting 1999 as the income year, the lender was required to engage in bona fide collection activities within 31 days following the year of loss. That did not occur. The IRS is precluded from collecting tax on income as long ago as 1999.
A lesson from this case adding detail to CPA course review is that issuance of a 1099-C does not automatically demand reporting of taxable income. Applying tax statutes to the facts and circumstances of each taxpayer actually determines the year of income.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.