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Forgiven Debt Income

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Mark Cappel
UpdatedMar 24, 2023
A collection agent was unable to verify a debt. It later filed a 1099-C for cancellation of debt income. Is that legal?

If a debt is deemed to be invalid because a third-party debt collection agency could not produce evidence that the individual actually owed the debt (bare account), then can the third party debt collector report the uncollectible debt as "forgiven income" to the IRS?

Thank you for your excellent question about forgiven debt and its potential effects on your income taxes. Your question raises a number of issues, including:

• What is verified or validated debt?

• What is forgiven debt income?

• Can a creditor report uncollectible debt as forgiven income?

Collection and Debt Validation

Collection agents work in one of two ways. First, they may work as an agent on behalf of the original creditor -- the credit card issuer, department store credit department, medical service provider, or other organization that is owed money. Second, the collection agent may purchase a collection account from an original creditor.

Actually, it is rare for a collection agent to buy a single collection account from an original creditor. It is customary for creditors to sell collection accounts to companies that place a number of collection accounts into a pool or portfolio, which is then sold to a collection agency.

The portfolios may be bare or fully documented. A bare account will consist of the following information:

• Account Number

• Balance

• Open Date

• Last Pay

• Charge-Off Date

• Name

• Social Security Number

• Last Known Address

• Last known telephone number

• Debt Type

• Issuer

Debt collection is governed by a federal law Section 809(b), 15 U.S.C. § 1692, which is also known as the Fair Debt Collection Practices Act (FDCPA). When a collection agent contacts a consumer the first time regarding a debt, the consumer has 30 days after receiving the initial communication to request a debt verification, which is sometimes called debt validation. Five days after the initial communication, the collection agent must give notice to the consumer that he or she has the right to verify the debt. A collection agent need not respond to a request for verification if the consumer sends the request after this 30-day period.

The collection agent can either provide verification/validation of the debt and continue collection activity, or the collection agent must stop collection activity until it provides the consumer with verification of the debt. Under the FDCPA, collections must cease until verification is mailed to the consumer.

What happens behind the scenes during the verification/validation process? In some cases the account is returned to the original creditor for research and assembly of materials and proof of the debts. The proof may consist of copies of receipts and invoices, and other itemized evidence that would prove that transactions took place, such as the original amount due and the payment history. Also, a copy of the original loan agreement or credit card application, or lacking that, account statements from the original creditor will help establish debt validation/verification. If the collection agent can provide detailed account information, collection activity can proceed.

A collection account containing itemized details is known as a fully documented account, and is in contrast to a bare account, which contains no details.

If the collection agent cannot validate/verify the debt, collection activity on that debt must cease. Additionally, debt that cannot be validated/verified cannot be reported to the credit reporting agencies (i.e., Equifax, Experian, and TransUnion). A collection agent that attempts to collect on a debt it cannot verify is in violation of the FDCPA. Also, a collection agent is in violation of the FDCPA if it reports a debt it cannot validate to a credit reporting agency.

Cancellation of Debt Income (CODI)

Under federal law, a financial entity is required to send a taxpayer a "Form 1099C Cancellation of Debt" whenever it forgives or cancels a loan balance greater than $600. This may create a tax liability for you because the canceled debt is considered "income" for tax purposes. The amount of debt forgiven must be reported on Form 982 and this form must be attached to the taxpayer's tax return. See also, IRS article on Home Foreclosure and Debt Cancellation.


In my opinion, it is not reasonable for a consumer to pay taxes on debt that cannot be validated. Let us take an example of debt relating to identity theft. It would add an additional injury for a identity theft crime victim to pay taxes for debt he or she never incurred. Invalid or unverified debt is just that -- a collection account that contains insufficient proof that the alleged debtor owes the debt.

However, I hasten to add I am unable to find case law or and IRS document that supports my position. Readers, if you know of such a case please inform me in the comments section below.

If you receive a 1099-C for a debt the creditor cannot validate / verify, contact the Taxpayer Advocate Service and explain your situation. Alternatively, consult with an attorney who has federal tax experience. Finally, file a complaint with the Federal Trade Commission.

I hope this information helps you Find. Learn & Save.



Struggling with debt?

If you are struggling with debt, you are not alone. According to the NY Federal Reserve total household debt as of Quarter Q4 2022 was $16.91 trillion. Student loan debt was $1.60 trillion and credit card debt was $0.99 trillion.

According to data gathered by from a sample of credit reports, about 26% of people in the US have some kind of debt in collections. The median debt in collections is $1,739. Student loans and auto loans are common types of debt. Of people holding student debt, approximately 10% had student loans in collections. The national Auto/Retail debt delinquency rate was 4%.

Collection and delinquency rates vary by state. For example, in South Carolina, 17% have student loan debt. Of those holding student loan debt, 10% are in default. Auto/retail loan delinquency rate is 7%.

Avoiding collections isn’t always possible. A sudden loss of employment, death in the family, or sickness can lead to financial hardship. Fortunately, there are many ways to deal with debt including an aggressive payment plan, debt consolidation loan, or a negotiated settlement.

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