Lessons to be Learned
Settlement of Credit Card Account Resulted in Tax and Penalties

If you have ever disputed an erroneous charge on your credit card statement, make sure you put your correspondence in writing and retain the records of your communication. In a recent tax case, the taxpayer learned the hard way about the tax implications of failing to do so.

In the fall of 1999, a taxpayer received a credit card bill for $36,000. He called the credit card company and informed them that only $6,000 of the charges were made by him, and offered to pay that amount. In 2000, a collection agency contacted him attempting to collect the $36,000. He again informed them that the charges were not his, and offered to make payment in the amount of $6,000. On October 17, 2001, he received a letter from the collection agency stating that payment was now due for $6,000, under the terms arranged with the collection agency. On October 31, 2001, he paid the $6,000, and the collection agency recorded the payment as a settlement of a purchase dispute. The collection agency later issued Form 1099-C, Cancellation of Debt, reporting debt cancelled of $31,327 for 2001.

The IRS determined that he did not report the income on his 2001 return, and assessed tax and penalties based on the $31,327 reported by the collection agency. This case went to tax court, at which point the taxpayer argued that he did not realize income from the cancellation of the $30,000 claim, since someone not authorized by him made the charges to his account. The court was not persuaded that he did not receive income because he could not present any evidence, such as correspondence to or from the credit card company, notes of his discussions with the credit card company or documentation that the collection agency accepted his $6,000 payment as a settlement of his dispute with the credit card company in the amount of $30,000. The only documentation was from the collection agency, which indicated that there was a purchase dispute on the account and that they had cancelled the debt because of the taxpayer's inability to readily pay the outstanding balance. On these grounds, the court sustained the IRS's determination that the taxpayer was liable for $9,427 in tax and $1,885 in penalties for 2001.

Whenever disputing credit accounts, it is necessary to document the facts and issues in writing. Failure to do so may result in the IRS taking the word of the other party, and subjecting you to an unnecessary tax, even if you have valid reasons for not making payment.

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