Forgiven debt has become an increasingly significant element of Enrolled Agent tax work in recent years. A number of nuances about debt cancellation are discovered during EA training. Wise tax advice identifies unusual instances where debt cancellation is not taxable.
Unfortunately, common sense about tax on cancelled debt varies from the facts in Enrolled Agent study materials. Michael and Sharon Bross learned this lesson in Tax Court rather than from an EA. They made a purchase from a furniture store under a financing arrangement offered by a credit card company. Approval of the financing provided for no accrual of interest if the charges for furniture purchase were paid by a specified date.
Unfortunately, Mr. and Mrs. Bross misinterpreted the financing agreement. They failed to note that any debt not extinguished by the specified date would incur computation of interest retroactive to the purchase date. When they were charged the back interest, they thought that a mistake was made. In fact, the error was a result of Mr. and Mrs. Bross not following the interest-free terms of the finance arrangement.
But the difficulty did not end there. Mr. and Mrs. Bross attempted to reach a settlement with the credit card company. During the dispute, additional interest and late payment penalties accrued. Settlement of the debt resulted in the credit card company accepting a partial payment of the accumulated balance owed. The remaining indebtedness was written off by the credit card company, which issued a Form 1099-C for the cancelled debt.
The familiar step from an Enrolled Agent course is ascertaining the facts that triggered the 1099-C. For Mr. and Mrs. Bross, the circumstances certainly called for some EA advice. They believed the $3,214.28 was non-taxable because it represented interest and late fees – money they never received. However, the cost for use of funds is taxable income if it is not repaid.
Whether they intentionally ignored the financing agreement or simply failed to understand it clearly is uncertain. Mr. Bross is an attorney and Mrs. Bross is a real estate agent. Despite their obvious educational levels, neither possessed the tax knowledge of an expert with EA certification.
In fact, the Tax Court expected Mr. and Mrs. Bross to have a superior grasp on their debt situation due to their professional statures. The court ruling starts by pointing out that the claim of credit card company misrepresentation is dubious. Anyway, debt is not disputable as authentic merely because the borrowers fail to comprehend the terms. Consequently, the proper action for Mr. and Mrs. Bross was to consult a professional for Enrolled Agent tax advice about reporting cancelled debt as 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.