It seems that some bottom-feeding debt collection companies—the ones who buy old debts that are frequently beyond the point where you can be sued for collection (what the FTC calls “time-barred debts”)—purchase old debts, mark them up with incredibly high penalties and fees, then “forgive” them and write them off as tax losses and send the debtors 1099-C forms—which means you have to pay taxes on the forgiven amount. If this happens to you, here are a few things you should consider first.
Every state has its own statute of limitations that determines when you can no longer be sued for old debt; however, the FTC says that doesn’t prevent collection agencies from attempting to collect time-barred debt provided they don’t harass you or engage in anything illegal. Collection companies aren’t allowed to collect more than the original debt, “unless your state law permits such a charge.” Debt included in a bankruptcy can’t be collected at all.
To be considered a “forgiveness of debt” (and therefore taxable), the amount has to be less than the original debt.
None of this answers whether or not it’s possible for the following to occur:
- 1. A collection agency legally (according to state law) adds lots of fees to your debt;
- 2. It then “forgives” your inflated time-barred debt without contacting you, resulting in a plus-sized 1099-C in your mailbox.
If you receive an unexpected 1099-C for a time-barred debt, you should definitely contact an accountant or lawyer to review your options, and to make sure that what the collection agency is doing is legal.
(Thanks to Royce!)