Our workplace lately encountered a state of affairs the place a mum or dad had co-signed on a student loan for his or her youngster, and the kid defaulted on the loan earlier than it was totally repaid. The bank forgave the stability of the student loan, however insisted on issuing a 1099-C (Cancellation of Debt) to the mum or dad within the quantity of the forgiven debt.
Section 108 of the Internal Revenue Code usually offers that the forgiveness or cancellation of a debt ends in taxable revenue to the debtor, which should be reported on the debtor’s revenue tax return.
While at first look it might appear affordable for loan signers and loan guarantors (co-signers) to be handled equally for tax functions, a distinction will be made by contemplating who reaps the advantages of the loan. The major borrower makes use of the proceeds of the loan (to attend college, buy a car, and so on.), whereas the co-signer solely has an obligation to pay the loan if the first borrower defaults. The IRS acknowledges this, and clearly excludes guarantors from the cancelled debt reporting necessities in Treasury Regulation 1.6050P-1(7):
Guarantors and sureties. Solely for functions of the reporting necessities of this part, a guarantor will not be a debtor. Thus, within the case of assured indebtedness, reporting underneath this part will not be required with respect to a guarantor, whether or not or not there was a default and demand for fee made upon the guarantor.
This distinction can be well-established in case regulation. In Landreth v. Commissioner, 50 T.C. 803(1968) the U.S. Tax Court defined:
The state of affairs of a guarantor will not be like that of a debtor who because of the unique loan obtains a nontaxable improve in belongings. The guarantor obtains nothing besides maybe a taxable consideration for his promise. Where a debtor is relieved of his obligation to repay the loan, his web price is elevated over what it will have been if the unique transaction had by no means occurred. This actual improve in wealth could also be correctly taxable. However, the place the guarantor is relieved of his contingent legal responsibility, both due to fee by the debtor to the creditor or due to a launch given him by the creditor, no beforehand untaxed accretion in belongings thereby ends in a rise in web price. Payment by the principal debtor doesn’t improve the guarantor’s web price; it merely prevents it, professional tanto, from being decreased. The guarantor no extra realizes revenue from the transaction than he would if a twister, bearing down on his residence and threatening a loss, adjustments course and leaves the home intact. 50 T.C. at 813 (emphasis added) (citations omitted) (quoted and adopted in Bullock v. Commissioner, T.C. Memo 2017-219).
If you obtain a 1099-C for a forgiven loan that you just co-signed, you must contact the lender and clarify that the 1099-C was issued in error, and ask them to subject a correction. If the lender refuses to appropriate the 1099-C, you must search the help of an skilled tax skilled to make sure your return is ready accurately.
The Willi Law Office, LLC, has been offering customized tax and authorized companies to people and companies in Westerville and Central Ohio for over 20 years.