Debt Settlements May Be Voided And the Money Due Anyway

A recent posting, “An IRS 1099-C Form Does Not Mean Debt is Discharged” caught my eye. It highlights a great potential risk for people that use debt settlement to eliminate their debt. The surprise is that while they think the debt settlement process has discharged their debt, it absolutely might not.

A third circuit bankruptcy case recently decided that Form 1099-C does not establish that debt is discharged. A creditor typically issues a Form 1099-C to a debtor in bankruptcy to show cancellation of debt. The credit union in the case In re Bononi, had sent the Chapter 7 debtor zero-balance account statements and an IRS form 1099-C for “cancellation of debt.” After receipt of the form and the account statements, the debtor received money from the settlement of a personal injury action.

The court found that despite the statements and the 1099-C form, the debtor still had an obligation to pay on the past debt. Additionally, the court found that even if a creditor issues a 1099-C form, the form does not prohibit the creditor from pursuing collection of the old debt. Only a discharge from the Bankruptcy Court has the effect of canceling the debt and removing the debtor’s liability for the debt. In re Bononi, 19 CBN 864. – Source

I’m still researching this issue but from what I have found so far, it is in fact, true. When a creditor writes off a debt or settles a debt, unless they agree the debt has been paid in full, satisfied, and no additional amount is due, then the part of the debt written off may be collected at a latter date.

The reason, the write off of the debt is an accounting function and the issuance of the 1099-C to the IRS is for tax purposes. The write off of the debt and issuance of the 1099-C does not erase the underlying obligation.

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This is a big deal. With creditors stressed and pressured for income, I can certainly see a creditor selling their written off debts for pennies on the dollar to generate yet more revenue from them. These would be sold to collectors that are prepared to fight the settlement offers. While the part paid in the settlement would be paid, it is the amount forgiven that could be collected.

And for all the critics that say this will never happen, my response is that it just has not happened yet in mass, but it certainly may. It’s a profit center waiting to be exploited and we all know how much banks love profits.

My bet is the most likely consumers to be hit with this will be all the people that are currently working with one of the commercial debt settlement companies that may soon go out of business. See 85% of Debt Settlement Companies May Be Closing Soon and Taking Your Money With Them. These companies will go bankrupt and the supporting documentation for any debt settled will most likely vanish with them.

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Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
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