Newton et al v. Beneficial Financial I, Inc. et al

Brief / Memorandum in Support re MOTION to Dismiss Plaintiffs' Complaint for Injunction, Damages and Declaratory Judgment .

W.D. Va.September 23, 2016

IN THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF VIRGINIA (Charlottesville Division) TONIA WOODSON NEWTON MICHAEL EARLY WOODSON DONALD LEWIS WOODSON, JR., Plaintiffs, v. Case No.: 3:16-cv-00058-GEC BENEFICIAL FINANCIAL, INC. DITECH FINANCIAL, L.L.C., Defendants. MEMORANDUM IN SUPPORT OF MOTION TO DISMISS PLAINTIFFS’ COMPLAINT FOR INJUNCTION, DAMAGES, AND DECLARATORY JUDGMENT Defendant, Ditech Financial, LLC (“Ditech”), by counsel, submits this Memorandum in Support of its Motion to Dismiss Plaintiffs’ Complaint for Injunction, Damages, and Declaratory Judgment (“Complaint”). INTRODUCTION Plaintiffs premise every cause of action in their Complaint on an incorrect legal conclusion that the filing of a 1099-C Cancellation of Debt form with the Internal Revenue Service operates to cancel or discharge a debt owed by Plaintiffs’ deceased mother. The Fourth Circuit and a majority of courts across the country have held that the issuance of a 1099-C form does not actually cancel the debt. Also, the plain language of the IRS regulations governing Forms 1099-C negates such an assumption. Consequently, there is no obligation for Ditech, the owner the subject debt, to release the deed of trust securing the repayment of the mortgage it Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 1 of 10 Pageid#: 383 2 holds. Because all seven of Plaintiffs’ claims are based upon the misguided assumption that the debt was cancelled, their Complaint should be dismissed in its entirety. BACKGROUND On January 26, 2005, Judith Woodson obtained a loan from Beneficial Mortgage Company of Virginia secured by real property located at 1967 Red Hill Road, Gordonsville, Virginia 22942 (the “property”). The loan was secured by a Deed of Trust and evidenced by a Loan Repayment and Security Agreement. (Compl., ¶ 6). Ms. Woodson subsequently obtained a Home Equity Line of Credit from Beneficial Discount Company of Virginia on March 30, 2006. Defendant Beneficial Financial I, Inc. (“Beneficial Financial”) succeeded to the interests of Beneficial Discount. (Compl., ¶ 11). According to Plaintiffs, Beneficial Financial assigned the Line of Credit to Ditech after issuing a Form 1099-C. (Compl., ¶¶ 12, 17). Ditech is not alleged to have any involvement with respect to the first mortgage debt instrument; Plaintiffs only allege Ditech was assigned the Line of Credit after Beneficial Financial had submitted Form 1099-C. Judith Woodson passed away in March 2015. (Compl., ¶ 20). Prior to her death, she entered into a contract to sell the property to her son, Plaintiff Donald Woodson. (Compl., ¶ 19). The contract sale price was only sufficient to satisfy the first mortgage loan. (Id.). In 2012, Beneficial Financial submitted IRS Tax Form 1099-C to the IRS for the Line of Credit. (Compl., ¶ 12-13, Exh. D). As a result of this solitary action, Plaintiffs allege that Beneficial Financial cancelled mortgage debt instrument on the Line of Credit. Plaintiffs offer no other facts that even suggest that either Beneficial Financial or Ditech forgave the debt owed on the Line of Credit. In fact, Plaintiffs admit that Beneficial Financial and Ditech refused to release the Line Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 2 of 10 Pageid#: 384 3 of Credit deed of trust or otherwise acknowledge that the debt had been satisfied. (Compl., ¶¶ 23-24). All causes of action stem from the conclusion that the 1099-C discharged the lien for the Line of Credit and cancelled the Deed of Trust. Plaintiffs now seek to quiet title, for compensatory damages and attorney’s fees against Beneficial Financial as a result of the failure to release the lien. While not expressly defined, those causes of action that directly concern Ditech or its interests include Count I: Plaintiffs’ request to quiet title and release the Line of Credit debt instrument; Count II: Plaintiffs’ request to order the removal of the Line of Credit deed of trust from the land records and the payment of attorneys’ fees; and Count IV: request for a declaration that neither defendant is entitled to foreclose as a result of a failure to remove the Line of Credit deed of trust from the land records.1 LEGAL STANDARD To survive a Rule 12(b)(6) motion to dismiss, a complaint must “provide ‘enough facts to state a claim to relief that is plausible on its face.’” Robinson v. Am. Honda Motor Co., 551 F.3d 218, 222 (4th Cir. 2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (citing Twombly, 550 U.S. at 556). Although a court must accept as true all well-pleaded factual allegations and construe them in the plaintiff’s favor, Edwards v. City of Goldsboro, 178 F.3d 231, 244 (4th Cir. 1999), the same is not true for legal conclusions, Iqbal, 556 U.S. at 678. “Threadbare recitals of the elements of a cause of action, supported by 1 While Plaintiff seeks a declaratory judgment in Count V regarding the unavailability of the First Mortgage Debt Instrument, their allegations make evident that Ditech neither owns nor services the first mortgage debt instrument and therefore Count V is not directed to it. Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 3 of 10 Pageid#: 385 4 mere conclusory statements, do not suffice.” Id.; Chamblee v. Old Dominion Sec. Co., LLC, No. 3:13cv820, 2014 U.S. Dist. LEXIS 50726, at *4 (E.D. Va. Apr. 11, 2014). “Twombly and Iqbal also made clear that the analytical approach for evaluating Rule 12(b)(6) motions to dismiss requires courts to reject conclusory allegations that amount to mere formulaic recitation of the elements of a claim and to conduct a context-specific analysis to determine whether the well- pleaded factual allegations plausibly suggest an entitlement to relief.” Chamblee, 2014 U.S. Dist. LEXIS 50726, at *4. In deciding the motion, a court may consider the facts alleged on the face of the complaint as well as “matters of public record, orders, items appearing in the record of the case, and exhibits attached to the complaint” without converting a Rule 12(b)(6) motion into a Rule 56 motion for summary judgment. Moore v. Flagstar Bank, 6 F. Supp. 2d 496, 500 (E.D. Va. 1997) (quoting 5A Charles A. Wright & Arthur R. Miller, FED. PRAC. & PROC. § 1357 (1990)); see Pueschel v. United States, 369 F.3d 345, 353 n.3 (4th Cir. 2004) (citations omitted). “Consideration of a document attached to a motion to dismiss ordinarily is permitted only when the document is integral to and explicitly relied on in the complaint.” Zak v. Chelsea Therapeutics Int’l, Ltd., 780 F.3d 597, 606-07 (4th Cir. 2015) (quoting Am. Chiropractic v. Trigon Healthcare, 367 F.3d 212, 234 (4th Cir. 2004)) (alteration in original). ARGUMENT Plaintiffs conclude—solely based on Beneficial Financial’s filing of Form 1099-C—that the Line of Credit debt was cancelled or forgiven. However, “the IRS did not create the form as a means of effectuating the discharge of a debt. It is, instead, a reporting mechanism to the IRS. Moreover, because a creditor can be required to file a Form 1099-C even where a debt has not been cancelled, the mere fact that a Form 1099-C is filed does not constitute sufficient evidence, Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 4 of 10 Pageid#: 386 5 standing alone, that a debt has been cancelled.” FDIC v. Cashion, 720 F.3d 169, 180 (4th Cir. 2013); see also Diaz v. Green Tree Servicing LLC, 2016 U.S. Dist. LEXIS 47318 (W.D. Wash. Apr. 7, 2016) (“[A] Form 1099-C alone is not competent evidence that a debt has been cancelled.”). This interpretation of the effect of Form 1099-C “is consistent with the regulation’s plain meaning, the interpretation by the IRS itself, and the majority of courts in the United States.” Verdini v. First Nat’l Bank of Pa., 135 A.3d 616, 621 (Sup. Ct. Pa. 2016). I. The plain meaning of the IRS Regulations confirms that a Form 1099-C does not actually cancel a debt such that the lien should be released. Form 1099-C is a reporting obligation a creditor owes to the IRS, not a representation or admission the creditor makes to the debtor. The IRS requires that any entity discharging an indebtedness to file “an information return on Form 1099-C.” 26 C.F.R. § 1.6050P-1(a). A “discharge of indebtedness” occurs “if and only if there has occurred an identifiable event described in paragraph (b)(2) of this section, whether or not an actual discharge of indebtedness has occurred. Id. (emphasis added). There are eight identifiable events that operate to activate the reporting requirement, which include a discharge of indebtedness through bankruptcy; the expiration of a statute of limitations for collection; a cancellation as a result of an election of foreclosure remedies that statutorily extinguishes the creditor’s right to pursue collection; a discharge pursuant to an agreement of the parties; a discharged based on a creditor’s decision to discontinue collection activity; or the expiration of a non-payment testing period. 26 C.F.R. § 1.6050P-1(b)(2). An identifiable event includes circumstances where “actual discharge of indebtedness has not yet occurred or is not contemplated.” FDIC v. Cashion, 720 F.3d 169, 178 (4th Cir. 2013). “The plain language of the regulation leads [the Fourth Circuit] to conclude that filing a Form 1099-C is a creditor’s required means of satisfying a reporting obligation to the Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 5 of 10 Pageid#: 387 6 IRS; it is not a means of accomplishing an actual discharge of debt, nor is it required only where an actual discharge has already occurred.” Id. at 179. II. The majority approach gives deference to the IRS’s own interpretation of Form 1099-C, which is not an admission that the debt has been discharged. Solely as a result of the issuance of Form 1099-C, Plaintiffs conclude that the Line of Credit debt was cancelled and the lien should have been released. However, the majority of courts have held Plaintiffs’ position to be legally incorrect; instead, courts abide by the plain meaning of the IRS regulations to hold that Form 1099-C is not an admission that a debt has been cancelled. In further support of the accuracy of this position, the IRS has provided internal guidance regarding the effect of Form 1099-C on the indebtedness. The IRS responded to a creditor’s concerns about the effect that compliance with the reporting requirements for Form 1099-C could have on a debtor’s obligation to pay outstanding debts. The IRS clarified that it does not view a Form 1099-C as an admission by the creditor that it has discharged the debt and can no longer pursue collection. Section 1.6050P-1(a) of the regulations provides that, solely for purposes of reporting cancellation of indebtedness, a discharge of indebtedness is deemed to occur when an identifiable event occurs whether or not an actual discharge of indebtedness has occurred on or before the date of the identifiable event. IRS Info. Ltr. 2005-0207. (A copy is attached as Exhibit 1). Nor does the IRS prevent collection activity after the filing of Form 1099-C. IRS Info. Ltr. 2005-0208. (A copy is attached as Exhibit 2). The IRS’s interpretation of its own regulations is “entitled to respect . . . to the extent that [its] interpretations have the power to persuade.” FDIC v. Cashion, 720 F.3d at 179(quoting Christensen v. Harris County, 529 U.S. 576, 587 (2000)). The Fourth Circuit has found the IRS’s informational letters persuasive because they “fully encompass[] the purpose of a Form 1099-C as an IRS reporting document and follow[] the plain language of the relevant Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 6 of 10 Pageid#: 388 7 regulation.”); but see cases affording the IRS Informational Letters an even higher degree of Chevron deference: In re Zilka, 407 B.R. 684, 688 (W.D. Br. Pa. 2009) (“The Internal Revenue Service[, which regulatory agency is the one that promulgated 26 C.F.R. § 1.6050P-1, and whose interpretation of the same is thus entitled to great deference,] does not view a Form 1099-C as an admission by the creditor that it has discharged the debt and can no longer pursue collection thereon (quoting Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843-45 (1984), IRS Info. Ltr. 2005-0207)); Capital One, N.A. v. Massey, 2011 U.S. Dist. LEXIS 83817, at *10 (S.D. Tex. Aug. 1, 2011) (“The IRS’s interpretation of regulations over which it has authority are given great deference. Thus, this court adopts the view that a 1099-C does not discharge debtors from liability.”). Thus, the IRS itself does not deem Form 1099-C to discharge a debt as a matter of law, and its own interpretation is strongly persuasive, as the interpretation directly coincides with the question this Court must resolve. Form 1099-C is a reporting requirement; it does not actually operate to cancel a debt and does not prevent a creditor from collecting a debt. Plaintiffs’ assumption that Form 1099-C requires a debt to be released is therefore untenable, and those claims founded upon an incorrect conclusion as a matter of law should be dismissed. This reliance on the plain language of the regulations as well as the interpretation ascribed to the regulations by the IRS itself has been followed by a majority of courts across the United States. See FDIC v. Cashion, 720 F.3d at 178 (“The IRS, the administrative agency charged with the obligation of implementing IRC § 6050P through its regulations, thus treats the Form 1099-C as a means for satisfying a reporting obligation and not as an instrument effectuating a discharge of debt or preventing a creditor from seeking payment on a debt.”); Mennes v. Capital One, N.A., 2014 U.S. Dist. LEXIS 61729 (W.D. Wisc. May 5, 2014) (“I find Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 7 of 10 Pageid#: 389 8 the IRS interpretation persuasive and agree with the majority of courts addressing this issue that without additional evidence, the filing of a 1099-C form does not by itself evidence debt cancellation as a matter of law.”); Capital One, N.A. v. Massey, 2011 U.S. Dist. LEXIS 82817 (S.D. Tex. Aug. 1, 2011) (“The IRS does not view a 1099-C as a legal admission that a debtor is absolved from liability for a debt. . . Thus this court adopts the view that a 1099-C does not discharge debtors from liability.”); In re Zilka, 407 B.R. 684 (W.D. Bankr. Pa. 2009) (relying on the plain language of the regulation along with the IRS’s interpretation to conclude that “Forms 1099-C, as a matter of law, do not themselves operate to legally discharge debtors from liability”); Verdini v. First Nat’l Bank of Pa., 135 A.2d 616 (Sup. Ct. Pa. 2016) (“Pursuant to the language of section 1.6050P-1 and its interpretation by both the majority of United States federal and state courts and the IRS itself, we conclude that the trial court properly found that issuing the Form 1099-C did not evidence a cancellation of Appellants’ debt.”); Chivaho Credit Union v. McGuire, 2012 Ohio 5878, P14 (Ct. App. Ohio Nov. 28, 2012) (deferring to the interpretation of the IRS that the issuance of Form 1099-C does not render a debt uncollectible). Plaintiffs solely base their allegation that the Line of Credit debt has been cancelled and should have been released on the issuance of Form 1099-C. As a matter of law the form does not operate to cancel a debt. Because all of Plaintiffs’ causes of action stem from this fallacious legal premise, they all fail. Nor does Plaintiffs’ conclusory assertion that Judith Woodson obtained tax liability as a result of the issuance of Form 1099-C alter the legal impact of Form 1099-C or elevate Plaintiffs’ allegations such that they withstand dismissal. First, to the extent Plaintiffs are asserting some sort of damage as a result of wrongful tax collection activities, their “exclusive remedy would be provided by 26 U.S.C. § 7426, 7433(a).” Dues v. Capital One, N.A., 2011 U.S. Dist. LEXIS 96435, at *16 (E.D. Mich. Aug. 8, 2011). Moreover, this issue of Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 8 of 10 Pageid#: 390 9 the potential tax liability of the debtor and tax benefit to the creditor has been considered and disregarded in light of the persuasive interpretation offered by the IRS regarding the effect of the filing of Form 1099-C. See, e.g., FDIC v. Cashion, 720 F.3d at 178 (while acknowledging a minority of courts address the inequities of allowing a creditor to collect a debt after receiving a benefit of a charge-off, the Fourth Circuit found the majority approach to follow the IRS’s interpretation more persuasive). CONCLUSION For the foregoing reasons, Ditech Financial, LLC, by counsel, respectfully requests that Plaintiffs’ Complaint for Injunction, Damages, and Declaratory Judgment be dismissed against it with prejudice. Dated: September 23, 2016 Respectfully submitted, DITECH FINANCIAL, LLC By: /s/ S. Mohsin Reza Of Counsel S. Mohsin Reza (VSB No. 75347) TROUTMAN SANDERS LLP 1850 Towers Crescent Plaza, Suite 500 Tysons Corner, Virginia 22182 Telephone: (703) 734-4351 Fax: (703) 448-6510 E-mail: mohsin.reza@troutmansanders.com Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 9 of 10 Pageid#: 391 10 CERTIFICATE OF SERVICE I hereby certify that on this 23rd day of September, a copy of the foregoing was filed with the Clerk of the Court using CM/ECF, which will send a notice of electronic filing to all registered users listed below. Henry W. McLaughlin, Esq. 8th and Main Bldg. 707 East Main, Suite 1050 Richmond, VA 23219 henry@mclaughlinvalaw.com Counsel for Plaintiffs David A. Rosen, Esq. Stradley Ronon Stevens & Young, LLP 1250 Connecticut Ave., N.W., Suite 500 Washington, D.C. 200036 drosen@stradley.com Counsel for Defendant, Beneficial Financial I, Inc. /s/ S. Mohsin Reza S. Mohsin Reza (VSB No. 75347) TROUTMAN SANDERS LLP 1850 Towers Crescent Plaza, Suite 500 Tysons Corner, Virginia 22182 Telephone: (703) 734-4351 Fax: (703) 448-6510 E-mail: mohsin.reza@troutmansanders.com Case 3:16-cv-00058-GEC Document 14 Filed 09/23/16 Page 10 of 10 Pageid#: 392 OFFICE OF CHIEF COUNSEL DEPARTMENT OF THE TREASURY I N T E R N A L R E V E N U E S E R V I C E WASHINGTON, D.C. 20224 October 07, 2005 Number: INFO 2005-0207 Release Date: 12/30/05 CC:PA:APJP:B01 GENIN-126798-05 UIL: 6050P.00-00 -------------------------- --------------------------- -------------------------------- ---------------------------------- Dear -----------------: This letter responds to your request for information dated May 10, 2005, regarding reporting cancellation of indebtedness under section 6050P of the Internal Revenue Code (Code). Specifically, you request information concerning the reporting obligations under section 6050P(c)(2)(D) for an organization that purchases debt. You state that your organization is in the business of purchasing debts in large pools at a significant discount. Other than purchasing debts, your organization does not lend money or originate loans. The debts that your organization purchases are often significantly delinquent. You state that your organization does not have the resources to pursue collection immediately on all debts that it purchases. Your organization prioritizes its collection activities based on debts with the most anticipated success of collecting. Often the purchased debts are settled for an amount less than the full amount owed. You state that, although your organization does not actively pursue collection on all of the debts it purchases, it intends to pursue collection in the future. You state that if your organization is required to file Forms 1099-C, “Cancellation of Debt,” its ability to collect will be significantly impaired because: (1) courts may view the filing of a Form 1099-C as a written admission on the part of your organization that the debtor no longer owes the debt; and (2) a debtor may be less willing to make payments if he or she receives a copy of the Form 1099-C. You request information on the section 6050P(c)(2)(D) reporting obligations for an organization that purchases debt. You also request information on how the 36-month non-payment testing period identifiable event applies to an organization that purchases debt. EXHIBIT "1"Case 3:16-cv-00058-GEC Document 14-1 Filed 09/23/16 Page 1 of 3 Pageid#: 393 GENIN-126798-05 2 Organizations Required to Report Under Section 6050P(c)(2)(D) Section 6050P(a) of the Code provides that any applicable entity that discharges indebtedness of any person during a calendar year must file an information return reporting the discharge. Section 6050P(d) provides that every applicable entity required to file a return under section 6050P(a) must furnish a copy of the information return to the debtor. Section 6050P(b) provides that no information reporting is required under section 6050P(a) if the amount of the discharge is less than $600. Section 6050P(c)(2)(D) defines an “applicable entity” to include an organization with a significant trade or business of lending money. Section 1.6050P-2(a) of the Income Tax Regulations (regulations) provides that lending money is a significant trade or business if the organization lends money on a regular and continuous basis during the calendar year. Section 1.6050P-2(e) provides that lending money includes acquiring an indebtedness. An organization that purchases debt may be an organization with a significant trade or business of lending money for purposes of section 6050P(c)(2)(D) of the Code and the regulations. The section 6050P(c)(2)(D) reporting requirements apply to discharges of indebtedness that occur on or after January 1, 2005. See section 1.6050P-2(i). The reporting requirements of section 6050P of the Code and the regulations apply on a calendar year basis. Section 1.6050P-1 of the regulations provides that, upon the occurrence of an identifiable event during a calendar year, an applicable entity must report cancellation of indebtedness of $600 or more during the calendar year unless an exception to reporting applies. Section 1.6050P-1(b)(2)(i) provides eight identifiable events that trigger the reporting requirement under section 6050P. 36-Month Non-Payment Testing Period Identifiable Event Section 1.6050P-1(b)(2)(i)(H) of the regulations provides a rebuttable presumption that an identifiable event has occurred for the calendar year if a creditor has not received a payment at anytime during a 36 month testing period ending at the close of the year. In applying the non-payment testing period to an organization that purchases debt, on December 31 of each year, the organization must determine how long it has not received payment. See section 1.6050P-1(b)(2)(iv). The section 6050P(c)(2)(D) reporting requirements apply to discharges of indebtedness that occur on or afte r January 1, 2005. See section 1.6050P-2(i). If the non-payment testing period identifiable event, or any other identifiable event, occurred prior to the effective date of section 1.6050P-2, no reporting is required upon the occurrence of a subsequent identifiable event. If, however, an identifiable event has not occurred before the effective date of section 1.6050P-2, an organization must determine if an identifiable event, including the non-payment testing period identifiable event, has occurred during 2005 or during any subsequent year for purposes of section 6050P reporting. EXHIBIT "1"Case 3:16-cv-00058-GEC Document 14-1 Filed 09/23/16 Page 2 of 3 Pageid#: 394 GENIN-126798-05 3 An organization can rebut the presumption that the non-payment testing period identifiable event occurred by engaging in significant, bona fide collection activity during the last 12 months that is more than nominal or ministerial. See section 1.6050P- 1(b)(2)(iv) of the regulations. This would require the organization to pursue collection activity beyond merely generating an automated mailing. See section 1.6050P- 1(b)(2)(iv)(A). The organization can also rebut the presumption if the facts and circumstances on January 31 of the following year indicate the debt has not been discharged. See section 1.6050P-1(b)(2)(iv). The facts and circumstances may include the existence of a lien relating to the debt. See section 1.6050P-1(b)(2)(iv)(B). To briefly address your concerns about whether courts may view the filing of a Form 1099-C as a written admission that the creditor discharged the debt, and that debtors would be less willing to pay after your organization files a Form 1099-C, you should note the following. The Internal Revenue Service does not view a Form 1099-C as an admission by the creditor that it has discharged the debt and can no longer pursue collection. Section 1.6050P-1(a) of the regulations provides that, solely for purposes of reporting cancellation of indebtedness, a discharge of indebtedness is deemed to occur when an identifiable event occurs whether or not an actual discharge of indebtedness has occurred on or before the date of the identifiable event. This letter calls your attention to certain general principles of the law. It is intended for informational purposes only and does not constitute a ruling. See Section 2.04 of Rev. Proc. 2005-1, 2005-1 IRB 1. If you have any additional questions, please contact our office at --------------------. Sincerely yours, Donna Welch Senior Counsel, Administrative Provisions & Judicial Practice (Procedure & Administration) EXHIBIT "1"Case 3:16-cv-00058-GEC Document 14-1 Filed 09/23/16 Page 3 of 3 Pageid#: 395 OFFICE OF CHIEF COUNSEL DEPARTMENT OF THE TREASURY I N T E R N A L R E V E N U E S E R V I C E WASHINGTON, D.C. 20224 October 07, 2005 Number: INFO 2005-0208 Release Date: 12/30/05 CC:PA:APJP:B01 GENIN-130393-05 UIL: 6050P.00-00 ------------------------------ ----------------------------------------------- ------------------------------ -------------------------------- Dear ------------------: This letter responds to your request for information dated May 18, 2005, regarding the requirements under section 6050P of the Internal Revenue Code (Code) for reporting cancellation of indebtedness. Specifically, you request information concerning the reporting requirements under section 6050P(c)(2)(D) for organizations that purchase debt. You state that your association’s members are organizations that purchase debt for less than the face value of the debt. You also state that these organizations generally pursue collection activity on purchased debts until the collection activity is either prohibited by law or the period for reporting the debt to a credit reporting agency expires. You state that an organization may purchase debt for a lump sum amount and may not know the breakdown of that amount into principal, interest, charges, and fees. Often these debts are settled for an amount less than the full amount owed. The typical settlement arrangement provides that the debtor will pay an amount equal to or approximating the principal balance due and that all interest, fees, and charges (to the extent these amounts can best be determined or estimated) will be discharged. You requested clarification on the section 6050P reporting rules in the form of published guidance or a private letter ruling. The Internal Revenue Service (Service) has decided to address your inquiries in the form of an information letter rather than published guidance or a private letter ruling . Before issuing the final regulations under section 6050P(c)(2)(D) of the Code, the Service published a notice of proposed rulemaking in the Federal Register on June 13, 2002. See 67 F.R. 40629. The notice of proposed rulemaking contained a rule that, for purposes of section 6050P(c)(2)(D), “lending money” includes acquiring an indebtedness. See section 1.6050P-2(e) of the proposed regulations. The notice of proposed rulemaking provided the opportunity for public comment; the Service did not receive any comments from organizations that purchase debt on the rule in section 1.6050P-2(e) before issuing the final regulations. The EXHIBIT "2"Case 3:16-cv-00058-GEC Document 14-2 Filed 09/23/16 Page 1 of 6 Pageid#: 396 GENIN-130393-05 2 Service is not in a position to address your concerns in published guidance at this time. In addition, your request does not meet the requirements of a private letter ruling request set forth in Rev. Proc. 2005-1, 2005-1 I.R.B. 1. Your inquiry poses several specific questions. We have grouped the questions and answers into the following categories. Q1. Who is required to report a discharge of indebtedness under section 6050P of the Code and when does the requirement to report arise? A1. Section 6050P(a) of the Code provides that any applicable entity that discharges indebtedness of any person during a calendar year must file an information return reporting the discharge. Section 6050P(b) provides that no information reporting is required under section 6050P(a) if the amount of the discharge is less than $600. Section 6050P(c)(2)(D) defines an “applicable entity” to include an organization with a significant trade or business of lending money. Section 1.6050P-2(a) of the Income Tax Regulations (regulations) provides that lending money is a significant trade or business if the organization lends money on a regular and continuous basis during the calendar year. Section 1.6050P-2(e) provides that lending money includes acquiring an indebtedness. An organization that purchases debt may be an organization with a significant trade or business of lending money for purposes of section 6050P(c)(2)(D) of the Code and the regulations. The section 6050P(c)(2)(D) reporting requirements apply to discharges of indebtedness that occur on or after January 1, 2005. See section 1.6050P-2(i). The reporting requirements of section 6050P of the Code and the regulations apply on a calendar year basis. Section 1.6050P-1 of the regulations provides that, upon the occurrence of an identifiable event during a calendar year, an applicable entity must report cancellation of indebtedness of $600 or more during the calendar year unless an exception to reporting applies. Section 1.6050P-1(b)(2)(i) provides eight identifiable events that trigger reporting of cancellation of indebtedness. Q2. How does the 36-month non-payment testing period identifiable event apply to an organization that purchases debt, and how may the organization rebut the presumption that this identifiable event has occurred? A2. Section 1.6050P-1(b)(2)(i)(H) of the regulations provides a rebuttable presumption that an identifiable event has occurred during a calendar year if a creditor has not received a payment during a 36 month testing period ending at the close of the year. In applying the non-payment testing period to an organization that purchases debt, on December 31 of each year, the organization must determine how long it has not received payment. See section 1.6050P-1(b)(2)(iv). The section 6050P(c)(2)(D) reporting requirements apply to discharges of indebtedness that occur on or after January 1, 2005. See section 1.6050P-2(i). If the non-payment EXHIBIT "2"Case 3:16-cv-00058-GEC Document 14-2 Filed 09/23/16 Page 2 of 6 Pageid#: 397 GENIN-130393-05 3 testing period identifiable event, or any other identifiable event, occurred prior to the effective date of section 1.6050P-2, no reporting is required upon the occurrence of a subsequent identifiable event. If, however, an identifiable event has not occurred before the effective date of section 1.6050P-2, an organization must determine if an identifiable event, including the non-payment testing period identifiable event, has occurred during 2005 or during any subsequent year for purposes of section 6050P reporting. An organization can rebut the presumption that the non-payment testing period identifiable event occurred by engaging in significant, bona fide collection activity during the last 12 months that is more than nominal or ministerial. See section 1.6050P- 1(b)(2)(iv) of the regulations. This would require the organization to pursue collection activity beyond merely generating an automated mailing. See section 1.6050P- 1(b)(2)(iv)(A). The organization can also rebut the presumption if the facts and circumstances on January 31 of the following year indicate the debt has not been discharged. See section 1.6050P-1(b)(2)(iv). The facts and circumstances may include the existence of a lien relating to the debt. See section 1.6050P-1(b)(2)(iv)(B). Q3. How should an organization that purchases debt report discharges of indebtedness if it does not know the breakdown of an amount owed into principal, interest, charges, and fees? A3. Section 1.6050P-1(c) of the regulations provides that an “indebtedness” means any amount owed and may include stated principal, fees, stated interest, penalties, administrative costs and fines. However, a discharge of interest is not required to be reported (see section 1.6050P-1(d)(2)), and only discharges of stated principal are required to be reported in the case of a lending transaction (see section 1.6050P- 1(d)(3)). Section 1.6050P-1(a)(1) of the regulations provides, in part, that an applicable entity must report the amount of the indebtedness discharged and any other information required by Form 1099-C, “Cancellation of Debt.” The amount of the discharged debt is reported in Box 2. Any amount of interest that is included in Box 2 is separately reported in Box 3. Accordingly, to report properly, an applicable entity must separately report the amount of discharged interest in Box 3 if it included the discharged interest in the total amount reported in Box 2 . If an applicable entity does not know the breakdown of a purchased debt into principal, interest, charges, and fees, it should try to obtain this information so that it can determine the amount of interest and principal discharged. If, however, the entity cannot obtain this information, the entity should report using the best available information. See Q&A8 for discussion of waiver of penalties for failure to file correct information returns and furnish correct information statements. EXHIBIT "2"Case 3:16-cv-00058-GEC Document 14-2 Filed 09/23/16 Page 3 of 6 Pageid#: 398 GENIN-130393-05 4 Q4. If an organization that purchases debt discharges an amount owed that includes interest and principal, is the organization required to report only discharges of stated principal of $600 or more? A4. Section 6050P(b) of the Code provides that no information reporting is required under section 6050P(a) if the amount of the discharge is less than $600. Section 1.6050P-1(a)(1) of the regulations provides that, except as provided in section 1.6050P- 1(d), an applicable entity must report cancellation of indebtedness of $600 or more during a calendar year. Section 1.6050P-1(c) defines indebtedness to mean any amount owed to an applicable entity, including stated principal, fees, stated interest, penalties, administrative costs, and fines. Section 1.6050P-1(d)(3) provides that an applicable entity is not required to report amounts other than stated principal in lending transactions. Section 1.6050P-2(e) provides that lending money includes acquiring an indebtedness. Although section 1.6050P-1(c) of the regulations provides a broad definition of what may constitute indebtedness for purposes of section 6050P of the Code, section 1.6050P-1(d)(3) provides that an applicable entity is required to report only stated principal in lending transactions. If an organization that purchases debt, which has a significant trade or business of lending money, discharges an amount owed that includes interest and principal, the organization is required to report only discharges of stated principal of $600 or more. Q5. Does filing a Form 1099-C upon the occurrence of an identifiable event prohibit future collection activity on the amount reported? A5. Section 1.6050P-1(a)(1) of the regulations provides that solely for purposes of the reporting requirements of section 6050P of the Code, a discharge of indebtedness is deemed to have occurred upon the occurrence of an identifiable event whether or not there is an actual discharge of indebtedness. Section 6050P and the regulations do not prohibit collection activity after a creditor reports by filing a Form 1099-C. Q6. Is an organization that is required to report under section 6050P of the Code also required to notify a debtor that it will report a discharge of indebtedness prior to filing or that the discharge may be gross income? A6. Section 6050P of the Code and the regulations do not require an applicable entity to notify a debtor that it will report a discharge of indebtedness prior to filing the Form 1099-C with the Service or that the discharge of indebtedness may be gross income. Section 6050P(d) provides, however, that an applicable entity required to file a return with the Service must also furnish a copy of the information return to the debtor. Q7. Does section 6050P of the Code require collection attorneys, collection agencies, or organizations that purchase debt to notify a debtor of the tax consequences of a EXHIBIT "2"Case 3:16-cv-00058-GEC Document 14-2 Filed 09/23/16 Page 4 of 6 Pageid#: 399 GENIN-130393-05 5 discharge of indebtedness resulting from a settlement at less than the full amount owed? A7. Section 6050P of the Code and the regulations do not require collection attorneys, collection agencies, or applicable entities to notify a debtor of the tax consequences of a discharge of indebtedness resulting from a settlement at less than the full amount owed. Q8. Does section 6050P of the Code or the regulations provide a safe harbor to protect a creditor who informs a debtor that it will report cancellation of indebtedness from inadvertent violations of the Fair Debt Collections Practices Act, state consumer protection laws, the Federal Trade Commission Act, and state deceptive trade practices acts? A8. Section 6050P of the Code and the regulations do not provide a safe harbor to protect a creditor who informs a debtor that it will report cancellation of indebtedness from inadvertent violations of the Fair Debt Collections Practices Act, state consumer protection laws, the Federal Trade Commission Act, and state deceptive trade practices acts. How the information reporting requirements of section 6050P impact other Federal or state consumer laws is beyond the scope of regulations under section 6050P. Q9. What penalties may the Service impose for failure to report under section 6050P of the Code, and are there circumstances in which the Service may waive the penalties? A9. Section 6721 of the Code provides a penalty for failure to file correct information returns with the Service. The Service may impose the penalty for: (1) a failure to file an information return before the due date, or (2) a failure to include all of the information required to be shown on the return or the inclusion of incorrect information. The penalty amount under section 6721 is generally $50 for each return with respect to which a failure occurs, not to exceed $250,000 per filer/per year. There are exceptions to the penalty and limitations to the maximum penalty amount that may be imposed if the filer corrects the failure within a specified time period, if the filer's failures to include information are de minimis, or if the filer's gross receipts do not exceed certain amounts. See section 6721(b)-(d). Section 6721(e) allows the Service to impose a higher penalty in the case of failures due to intentional disregard of filing requirements. Section 6722 of the Code provides a penalty for a failure to furnish correct information statements. The Service may impose the penalty for: (1) failure to furnish an information statement on or before the due date, or (2) failure to include all of the information required to be shown on an information statement or the inclusion of incorrect information. The penalty amount under section 6722 is $50 per failure, not to exceed $100,000 per filer/per year. Section 6722(c) allows the Service to impose a higher penalty in the case of failures due to intentional disregard. EXHIBIT "2"Case 3:16-cv-00058-GEC Document 14-2 Filed 09/23/16 Page 5 of 6 Pageid#: 400 GENIN-130393-05 6 Pursuant to section 6724 of the Code and the regulations, the Service may waive penalties under section 6721 and section 6722 if the filer can demonstrate that the failure is due to reasonable cause and not to willful neglect. A filer may obtain a waiver of the penalty if it can establish that either: (1) there are significant mitigating factors with respect to the failure, as described in section 301.6724-1(b) of the Regulations on Procedure and Administration, or (2) the failure arose from events beyond the filer’s control, as described in section 301.6724-1(c). In addition, the filer must demonstrate that it acted in a responsible manner, as described in section 301.6724-1(d), both before and after the failure occurred. This letter calls your attention to certain general principles of the law. It is intended for informational purposes only and does not constitute a ruling. See Section 2.04 of Rev. Proc. 2005-1, 2005-1 I.R.B. 1. If you have any additional questions, please contact our office at --------------------. Sincerely yours, Donna Welch Senior Counsel, Administrative Provisions & Judicial Practice (Procedure & Administration) EXHIBIT "2"Case 3:16-cv-00058-GEC Document 14-2 Filed 09/23/16 Page 6 of 6 Pageid#: 401 IN THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF VIRGINIA (Charlottesville Division) TONIA WOODSON NEWTON MICHAEL EARLY WOODSON DONALD LEWIS WOODSON, JR., Plaintiffs, v. Case No.: 3:16-cv-00058-GEC BENEFICIAL FINANCIAL, INC. DITECH FINANCIAL, L.L.C. Defendants. ORDER This matter came before the Court on the Motion to Dismiss Plaintiffs’ Complaint for Injunction, Damages, and Declaratory Judgment filed on behalf of Defendant, Ditech Financial, LLC. Upon consideration of the Motion, and all supporting documents, it is hereby ORDERED that the Motion is GRANTED. It is hereby further ORDERED that Plaintiffs’ Complaint for Injunction, Damages, and Declaratory Judgment is hereby DISMISSED with prejudice. IT IS SO ORDERED. ENTERED this _____ day of _____________________, 2016. _______________________________________ The Honorable Glen E. Conrad JUDGE, UNITED STATES DISTRICT COURT Case 3:16-cv-00058-GEC Document 14-3 Filed 09/23/16 Page 1 of 1 Pageid#: 402