The IRS matches third-party information reports with items reported on taxpayer’s tax returns. Typically this involves the IRS sending a CP2000 letter to a taxpayer advising that a W-2 or Form 1099 was not reported on the taxpayer’s tax return. We are now seeing many cases where in particularly Forms 1099 are being issued to taxpayers who did not work for the company shown on the Form 1099.
The United States Tax Court has recently addressed this issue in Martin v. Commissioner, T.C. Summary Opinion 2009-121, August 4, 2009. Pursuant to Section 7463(b), this decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.
On June 21, 1999, Steed A. Martin, Taxpayer, purchased a 1988 Toyota 4-Runner automobile. He financed the automobile through Heritage Community Credit Union (Heritage) by entering into a "Simple Interest Motor Vehicle Contract and Security Agreement" indicating that the price was $12,360.48, of which $8,872.34 was being financed with Heritage. Taxpayer stopped making payments on his loan with Heritage during 2001, and Heritage "charged-off" and "canceled" the $6,704.92 outstanding principal of Taxpayer’s loan.
Taxpayer was notified by Heritage in 2002 that his automobile was going to be repossessed, and soon thereafter a person came to his residence to repossess the automobile. Taxpayer turned over the keys for the automobile, and it was placed on a truck and transported from the vicinity of Taxpayer’s residence. Taxpayer did not subsequently see or have access to the automobile. During 2005 Heritage issued a Form 1099-C, Cancellation of Debt, to Taxpayer reflecting the cancellation of Taxpayer’s debt of $6,704.92. That information was also communicated to the Internal Revenue Service. Taxpayers did not report the $6,704.92 in income for 2005, and Respondent made an adjustment for increased income due to cancellation of indebtedness. The records of Heritage reflect that Taxpayer’s automobile was assigned for repossession.
At some point Taxpayer stopped making payments on the loan and was advised that the automobile would be repossessed. The automobile, which Taxpayer believed had a value equal to the outstanding principal on the loan, was taken from Taxpayer during 2002. Heritage had charged off the loan in 2001, but sent Taxpayer a Form 1099-C in 2005 reflecting cancellation of indebtedness income in the amount of the outstanding balance of the loan.
The only evidence in the record that supports Rrespondent’s determination of cancellation of indebtedness income is the Form 1099-C Heritage issued.
Section 6201(d) provides that in any court proceeding, where a taxpayer asserts a reasonable dispute with respect to any item of income reported on an information return (such as a Form 1099) filed by a third party, the Commissioner may have the burden of producing reasonable and probative information concerning the deficiency in addition to information on the information return.
Taxpayer disputed the correctness of the information return. Taxpayer testified that the automobile was repossessed by Heritage at a time when it had a value equal to the outstanding debt. That would mean that Heritage had received an asset with sufficient value to substantially reduce or eliminate the outstanding debt and would call in question whether the Form 1099-C was correct.
The Tax Court found that Taxpayer effectively called into question the validity of the Form 1099-C, and Commissioner did not placed in evidence any information that would rebut Taxpayer’s testimony, which is also supported by documentary evidence in the record. Therefore, the Tax Court found in accord with Section 6201(d), the Commissioner is not able to rely solely upon the Form 1099-C in support of the determination that Taxpayer has cancellation of indebtedness income.
Generally, a taxpayer must include income from the discharge of indebtedness. See Section 61(a)(12); sec. 1.61-12(a). Where indebtedness is being discharged, the resulting income would equal the difference between the amount due on the obligation and the amount paid, if any, for the discharge. See, e.g., Cronin v. Commissioner, T.C. Memo. 1999-22. This principle derives from the seminal case of United States v. Kirby Lumber Co., 284 U.S. 1 (1931), where the Supreme Court held that a taxpayer may realize income by paying an obligation at less than its face value.
Accordingly, income from cancellation of indebtedness would not include the entire amount of the outstanding debt if the creditor received payment or assets of value from the debtor. A cancellation of indebtedness generally produces income to the debtor equal to the difference between the amount due on the obligation and the amount paid for the discharge. If, however, no consideration is paid to or received by the creditor for the discharge, then the entire amount of the debt is considered income to the debtor. Section 61(a)(12).
The Tax Court accepted Taxpayer’s testimony on the value of the automobile, as an owner is presumed to know or have a good sense of the value of his property. There is no evidence in the record that is contrary to Taxpayer’s testimony. In addition, Taxpayer purchased the automobile during 1999 for $12,360.48. Two years later, when it was repossessed, a value of $6,704 would appear to be reasonable (one-half of its original value).
The Tax Court found under these circumstances, that the Form 1099-C has been refuted and discredited. Taxpayer showed that the debt was satisfied, and the Tax Court accordingly held that Taxpayer was not required to report cancellation of indebtedness income for 2005.
If there is any doubt that a taxpayer owes taxes as the result of an errouneous Form W-2 or Form1099, the taxpayershould challenge the IRS.