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Thursday, November 15, 2012

Tax Consequences of Occupy Wall Street's Rolling Jubilee Debt-Forgiveness Movement

Rolling JubileeThe Daily Beast: Debt and Taxes: What Are the Tax Implications of Forgiving America's Enormous Debt Burden?, by Megan McArdle:

A little while back, a reader wrote in to "Ask the Blogger" to inquire as to my opinion of Rolling Jubilee, an idea that grew out of Occupy Wall Street.  Basically, the notion is that you buy up distressed debt for pennies on the dollar, and then cancel it.  I've been meaning to answer this, but haven't gotten around to it, so here goes: it seems like a fine idea, as far as it goes.  It's non-coercive, and it helps both creditors and debtors to move on with their lives, rather than staying chained to this largely unrecoverable debt.

However, I would have added, there are limits to how far it goes, because debt cancellation is a taxable event, as Nick Summers just wrote in Businessweek.  If you cancel a $200,000 mortgage, that's treated as $200,000 worth of income to the borrower.  There are good reasons for this -- otherwise, we'd all get our paychecks as "loans" that would then be "forgiven" and the government would have to fund itself by looking under the Senate couches for spare change.

But the organization behind Rolling Jubilee, called Strike Debt, denies that this is so:

Will the Rolling Jubilee have to file a 1099-C Cancellation of Debt form with the IRS?

No. The Rolling Jubilee will earn no income from the lending of money and is therefore exempt from filing a Form 1099-C under the Internal Revenue Code Section 6050P.

Felix Salmon is quite critical of Summers for not even looking at the Rolling Jubilee FAQ:  

In other words, there will not be any tax consequences to what Strike Debt is doing, on the perfectly legal grounds, as Worstall has found in the tax code, that “you do not have income from canceled debt if the cancellation or forgiveness of the debt is a gift”.

To put it another way, the debtors will no more have to pay income tax on the forgiven debt than they would have to pay income tax if I gave them a gift of that money. What’s more, Strike Debt won’t report the cancellation to the IRS, and the debtor will probably not know that their debt has been forgiven. Given all that, the chances of the IRS coming after the debtor for income tax on the forgiven debt are exactly zero.

Updates to Summers piece suggest that the FAQ was actually put up in response to what he wrote, so there was no way for him to look at it before. More to the point, Felix's argument is wrong, at least for large gifts. You cannot (legally) gift someone a sizeable sum without one of you paying taxes on it--either gift taxes, or income taxes. The IRS has had a hundred years of people figuring out cute ways to avoid the income tax by calling "a large chunk of money" something other than "income". The odds that some wordsmith has discovered some novel semantic distinction that provides get-out-of-taxes-free card are very slim.  ...

Whether the IRS will treat this as a taxable event is, of course, a separate question from whether the IRS should treat it as a taxable event. I'm inclined to think that they shouldn't -- that either the IRS should laxly enforce this provision, or Congress should pass a law making this sort of charity explicitly legal. It would be a good thing to do for people who are overindebted, and it would also be a good thing to do for the economy.

Huffington Post: Premature Occupy Wall Street Group Effort Wants Consumer Debt to Vanish with Rolling Jubilee:

According to tax expert and CPA Jim Buttonow, a former IRS examiner, "This is a very complicated area of taxation. The amount that a taxpayer includes in income depends on the facts and circumstances in each case. The fact that a lender does not issue a Form 1099C does not determine whether or not the transaction is taxable. It is the facts and circumstances in each case.

It appears that OWS is not one of the organizations that is required to file a Form 1099C (again, see the instructions for Form 1099C that lists a host of organizations required to file Form 1099C).

If the debtor is going to take a different position on the forgiveness of debt (i.e. it is a gift), they better have substantial authority to do so. My guess is that it will not be applicable as a debt was cancelled, not fully paid for by someone else and intended to be a gift.

My recommendation: have OWS ask the IRS for a private letter ruling on the taxablity. It will provide the debtors a definitive position (assuming the IRS will rule on the issue) and eliminate the confusion."

(Hat Tip: Philip MacCabe.)

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Here's a possible theory: Treat the forgiven debt as not one gift from Rolling Jubilee (or Strike Debt, or whatever it's called), but rather as gifts from the various contributors to Rolling Jubilee, with RJ merely acting as their agent. Given the discounted value of the debt and the number of donors, it seeks likely that the amount of any single debtor's obligation that any one contributor is covering will be less than the annual gift tax exclusion (currently $13,000, and going up to $14,000 in 2013). Result: No income tax and no gift tax.

Another interesting question is the degree to which contributors can claim a Section 170 charitable deduction for the amounts they give to this effort. One fact that would be relevant to this question is the degree to which Rolling Jubilee has any evidence of need for those debtors whose debt is being forgiven. (It might be worth looking at IRS guidance for relief of victims of disasters to see whether there's some way to offer a deduction without such an inquiry.)

Posted by: John Pomeranz | Nov 16, 2012 1:23:46 PM