New debt-forgiveness tax rule will take effect in late December.
In January the Internal Revenue Service issued final rules governing when lenders must report discharges of borrower indebtedness. The rules are effective Dec. 22, 1996, and apply to discharges taking place on or after that date, Some exceptions are provided and special rules and effective dates apply to cases involving multiple debtors. While banks' burden increases, the new rules are somewhat of an improvement over the interim rules.
Broadly speaking, discharges are considered income to the "forgiven" party. The rules apply to discharges of $600 or more in a calendar year and require the lender to file Form 1099-C with IRS in the event of such discharges, The rules appeared in the Jan. 4, 1996, Federal Register.
The IRS will not apply penalties for failing to report in certain circumstances for a time, continuing its present policy through Jan. 2, 1997. In addition, banks can adopt the new rules tight away and apply them to discharges after Jan. 1, 1996, if they so choose.
Specific cases and exceptions
The government's temporary and proposed regulations were open to some interpretation in the matter of when a debt is considered discharged. Under those rules, a debt was considered discharged and reporting required when an "identifiable event" indicated the debt would never be repaid. Three such events were given, but the proposed rules stated that they were not exclusive examples.
Based on public comments, IRS set up an exclusive list of events. If none of these events occur, the new rules will not require a lender to file Form 1099-C. The events:
1. Discharge of indebtedness in bankruptcy--Such events include discharges made under Chapter 11 of the Bankruptcy Code. Creditors must report if they know that the indebtedness arose for business or investment purposes. They are not required to report in consumer bankruptcies and where the purpose of the loan was unclear or unknown.
2. Expiration of the statute of limitations for collection--These limits can vary from state to state and may not necessarily halt creditors from seeking repayment. The new rules hold that expiration of the statute only triggers reporting requirements if a court upholds the debtor's claim that the statute has expired and the period for appealing such decisions has expired.
3. Discharges of debt by "operation of law"--Four such events are listed in the new rules and only such events are covered:
