IRS Form 1099-C: Is the debt actually forgiven and released?

UPDATED August 25:
Judge Olson, at the end of an Order to Show Cause against several attorneys, in a short discussion, said that an issuance of a 1099 is not a basis to object to a Proof of Claim. Case no 10-49318(also can be seen at Case no 11-13345 JKO (DE 148) >(In re MacFArland)

The question often arises for a debtor as to the pros and cons of settling credit cards at a discount or a completing a short sale. The filing of a chapter 7 bankruptcy prior to any short sale or settlement should eliminate this problem because no debt is forgiven. Sometimes creditors on their own charge off an account and issue a 1099-c creating a taxable event for the recipient. This forgiveness of debt income is taxable, though an IRS Form 982 to show insolvency might often be used to avoid tax liability.

But does the filing of a 1099-c by the creditor mean the debt is released and that the creditor, or a debt purchasing company, can’t sue? Many would assume that the creditor cannot sue and that the issuance of the 1099 would be a defense. Similarly, could a creditor file a proof of claim in a bankrupcy after it had already issued a 1099C?

Bankruptcy courts have determined that the 1099c does not imply that the creditor has released its right to recover on the underlying debt or deficiency. In re Zilka, 407 BR 684(Bankr. W. D. Pa 2009). However, the debtor may have been forced to pay income taxes on the 1099. The creditor would then have to withdraw its 1099c reporting to IRS so that the debtor could receive a tax refund. Also see USA v Reed, 2010 U.S. Dist Lexis 96079(US D. Ct. E.D. Tenn.)

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