Dear Tax Talk,
I had a charge-off that was apparently reported to the Internal Revenue Service in 2010. In April 2012 I paid back approximately half of this debt. In July 2012 I was informed that I owed the IRS extra tax for 2010 because of this income. I sent them a copy of the receipt to try and get the amount reduced by half, as half had since been paid; therefore it’s not income. They were not impressed and are still after me for the full amount. Will I be able to deduct the paid portion on my 2012 taxes? How can I resolve this tax bill dispute with the IRS?
— Ken

Dear Ken,
There are various defenses to fight this tax bill battle, but your best bet would be to hire an accountant to represent you so that you prevail in this matter. If I understand you right, you owed someone, let’s say, a bank, money that you did not repay in 2010. The bank charged this off as an uncollectible account and issued you a Form 1099. It sounds like you didn’t include this debt in your 2010 taxes and the IRS probably sent you a correspondence exam letter, known as a CP2000, asking why you didn’t record this as income.

For some unknown reason you paid off half of this debt in 2012 and you believe that you shouldn’t have to pay tax in 2010 on this debt. I agree with you, the IRS is not seeing it right. Your defenses would be:

  • Determine if you were insolvent in 2010 when the debt was forgiven. Usually, lenders only forgive debts when they believe they cannot collect, meaning they think you don’t have the assets to pay. If, in fact, your debts exceeded the value of your assets at the time the debt was forgiven, the law allows you to exclude the debt from income.
  • If you repaid the loan in 2012, presumably the bank was still actively trying to collect from you. If this is the case, then the bank did not discharge the debt in 2010 and should retract the 1099. If the bank doesn’t retract the 1099, you may be able to convince the IRS that the 1099 was not issued in the right year as the bank continued collection efforts.
  • If you can’t get anywhere with the correspondence unit, which is likely, do not agree to anything. The correspondence unit will issue what is known as a 30-day letter. This means you have 30 days to appeal the decision. Your appeal goes to the IRS Appeals office, which is a higher level of tax examiner that has more flexibility to apply the law fairly.

Good luck and let me know how things turn out.

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