Smart TaxesSmart Taxes

A little-known form for avoiding big taxes

If you have gotten a 1099-C and you believe it's a mistake, there's a way to fight back, and it will keep the IRS from trying to collect in the meantime.

By Money Staff Feb 27, 2014 12:17PM

This post comes from Gerri Detweiler at partner site on MSN MoneyAn estimated 5.75 million forms reporting “cancellation of indebtedness income” have been sent to taxpayers this year. But how many of these 1099-C forms are correct? Given the complaints we’ve received on our blog, we suspect the number of mistakes is significant. Here are just a few examples of some of the mistakes our readers are battling:

Close up of hands filling in tax form © JGI, Blend Images, Getty ImagesVery old debt. I had a car lease back in 1997 for a vehicle. I received a deficiency letter from the IRS stating that I didn't claim it on my 2011 taxes. I never received the 1099 from GMAC… IRS is asking for a Fair Market Value of the vehicle that it sold for back in 1998. Like I am supposed to know that.

Debt due to fraud or identity theft. A friend for whom I do her taxes just received a 1099-C for $7.5K for credit card debt. She claims that she never applied for the credit card, never saw the card and never used it. She suspects that her late husband who passed away in 9/1999 applied for the card in her name after he trashed his credit.

Debt not owed. I have disputed the debt with the credit card company, in court twice when complaints were filed by attorneys and I maintain that I do not owe the debt. I do not owe the debt. What will happen if I simply ignore the 1099-C when I file my taxes?

Normally, when you receive a 1099-C, your goal is to find out whether you qualify for an exclusion or an exception that will allow you to avoid including this amount in your taxable income. You do that by reviewing the exceptions and exclusions described in Publication 4681 and then filling out Form 982 to report the one(s) for which you qualify.

But there is no place on that form to indicate that you believe that 1099-C is wrong. So how do you dispute it?

In his book How to Eliminate Taxes on Debt Forgiveness, tax professional Daniel J. Pilla describes the how do handle incorrect 1099-Cs. Here is an overview of the process he describes in detail in his book.

The first thing you must do if you receive one of these forms and you believe it’s wrong is dispute it with the creditor that issued it. Otherwise, the IRS (which receives a copy of it as well) will assume the amount listed on the form is correct. Write to the company and be very specific about why you believe it is incorrect. Ask the company to either withdraw it or to issue a corrected version, and give them a specific, reasonable deadline for doing so. Send your letter by certified mail with proof of delivery, and keep a copy for your records.

If the company does not respond, or does not cooperate, you will need to let the IRS know about your dispute. You do this by including IRS Form 8275, Disclosure Statement, with your tax return. On this little-known form, you will give the IRS a detailed explanation of why you believe the 1099-C you received is incorrect and why you do not believe you should have to include some or all of that income on your tax return. Explain that you tried to correct it with the issuer, and include a copy of that dispute along with proof of delivery so the IRS knows that you tried.

That may take care of it, or the IRS may question you about this issue. If that happens, make sure you respond to any questions or requests for information as quickly as possible.

He goes on to explain that if you can demonstrate a reasonable basis for your dispute, “the IRS will have the affirmative duty to produce evidence to support the accuracy of the Form 1099-C. That means the IRS will have to mine documents and information from the company in question and present a witness to support the claim.  Given the way banks, mortgage companies, credit card company and the like make and store their records, what do you suppose the chances are that the IRS will be able to produce such evidence?”

In his book, Pilla goes into more detail about circumstances where you can dispute these forms, and describes ways to legally avoid paying taxes on forgiven debt. For taxpayers who normally file their own taxes (with or without tax-preparation software), or hire a tax preparer who is not intimately familiar with these forms, this book does an excellent job of explaining this confusing topic.

When you dispute the Form 1099-C as outlined above, you can expect favorable results, says Pilla, but it might take a letter or two to get there. For example, while the IRS is likely to conclude the matter without further action, it is possible that its computer system will simply kick out a notice – Letter CP 2000 – since the Form 1099-C “income” is not reported on the tax return itself, Form 1040. If that happens, you have the right to appeal the determination.

By filing a simple protest letter, a sample of which is provided in Pilla’s book, your case is moved to the IRS appeals function where you have the opportunity to discuss your case with an appeals officer. This is a live person (you’re no longer dealing with computers and notices) to whom you will present your evidence and arguments. Assuming you’ve followed the above procedures, and further assuming the IRS is unable to locate any hard evidence to support the idea that you had debt forgiveness income in the year the 1099-C was issued, you will win your case.

In the meantime, the IRS is not permitted to begin collection action while your case is on appeal. As such, you don’t have to worry about wage or bank levies while you’re arguing about whether you owe the money in the first place. It is the threat of collection that keeps most people from challenging the IRS. But that risk is taken out of the equation when you file a timely appeal.

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Mar 16, 2014 9:19PM
One thing people forget is that if you have a non qualified account and your advisor owe taxes on gains.. Try to limit rebalancing on non-qualified accounts.
Also there are ways to defer taxes with savings.  For instance my life insurance policy from Life Ant grows cash value tax deferred.  Also a 401k will grow tax deferred.  Don't forget that any gains if not offset are realized in the tax year the trade happens on regular old brokerage accounts.
Feb 28, 2014 3:32PM

Make sure you report the free cookies as misc. income.

Feb 27, 2014 7:47PM
Last year I got some free cookies at my local bakery for tax day! I didn't know about the offer but it just so happened I went in to buy a sandwich and they let me know about the deal. I hope that this year I can find some of these lesser known deals and get some free stuff!

Luke  | <a href='' > Tax Specialists Of Northern Colorado LLC</a>  
Mar 17, 2014 4:01AM
I've got one that's bugging us. My wife's former employer decided to be "bought out" by a major health care facility. Her 401K plan included a loan that was being paid back by payroll deduction. Her new employer plan refuses to allow her to continue to pay on this loan so it's treated as an early distribution. Is this fair and is there some way to appeal this to the IRS? The remaining 401k funds were allowed to be transferred to the new employer retirement plan.
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