1099-C Filing Plus Debtor’s Income Tax Payment Equals Debt Cancellation

Posted by NCBRC - October 16, 2017

The mortgage creditor cancelled the underlying debt when it filed a “cancellation of debt” form with the IRS and the debtors paid income taxes on the cancelled debt. In re Lukaszka, No. 17-242 (Bankr. N.D. Ia. Aug. 4, 2017).

In their proposed chapter 13 plan, James and Darcey Lukaszka sought an order requiring First Federal Credit Union, a junior mortgagee, to release their mortgage lien on the basis that, four years earlier, First Federal had issued the debtors a “cancellation of debt” form, 1099-C, indicating that it was no longer seeking to collect on the debt. As a result, the Lukaszkas reported the almost $60,000.00 debt cancelation to the IRS as income and paid taxes on it.

First Federal objected to confirmation.

The court began with First Federal’s argument that the 1099-C “cancellation of debt” form was filed to comply with IRS regulations rather than to cancel the debt itself. The court noted that a majority of courts have found that the mere filing the form does not release a debtor from his legal obligation to repay the debt. Courts so finding reason that the creditor has an obligation under the Internal Revenue Service regulations to file without regard to its ultimate intentions with respect to the debt. On the other hand, a minority of courts have found that, because filing the form has consequences for both debtor and creditor with respect to tax obligations, filing is prima facie evidence of debt cancellation and shifts the burden to the creditor to prove otherwise.

The court found that it did not need to take a position on whether filing the 1099-C form, standing alone, is prima facie evidence of debt cancellation, however, because it had the additional fact of the debtors’ having paid taxes on the income. The court concluded that in the absence of any evidence indicating that First Federal did not intend to cancel the debt, the combined evidence of the 1099-C form and the debtors’ tax payment was sufficient evidence that the debt was cancelled. The court stated that it would be inequitable to find otherwise.

First Federal argued, in the alternative, that even if the underlying debt were deemed cancelled, it retained its in rem rights against the property securing the loan, and ordering release of the lien would modify its rights in violation of section 1322(b)(2). The court disagreed, finding that, under Iowa law, a mortgage is not an independent obligation and therefore does not survive the termination of the underlying debt. Thus, section 1322(b)(2) was inapplicable and First Federal had no rights against the property itself.

The court thus overruled First Federal’s objection to confirmation.

Lukaszka Bankr. ND Ia Aug 2017

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