A Primer on some Debt Issues

Remember this past June when John Oliver, host of Last Week Tonight made headlines by purchasing $15 million worth of medical debt for $60,000 and then finding a way to forgive the debt so those who owed the money would not face any tax consequences?

Because that item continues to make the rounds online I thought a review of a few of the facts about what he did might be in order.

Why was the debt so inexpensive to purchase?

Buying this debt for four cents on the dollar was only possible because all of the debts that made up the total amount were beyond the statute of limitations.  That means that whoever owns the debt cannot file a lawsuit or use the legal system to collect.  They can still contact the person who owes the money but in doing so they are supposed to comply with the federal statutes that were passed by Congress to protect us from debt collectors.

What happens if I make a partial payment on my debt when it is beyond statute?

You restart "the clock" on the statute.  When I was hospitalized for a year and my former employer illegally canceled my health insurance while I was in a coma.  In spite of my going on Medicaid, there were some very large medical bills that weren't paid due to the incompetence of the billing offices of the providers.  As a result they tried to collect them from me.  Under California law after four years have passed the debt collectors can no longer sue.  That did not stop them from calling me incessantly.

Had I been foolish enough to make a partial payment "in good faith" as many of them tried to get me to do, that would have restarted the four year period during which they could take legal action.

So if you owe someone money that is beyond the statute of limitations, while it may negatively impact your credit (after seven years the negative credit reports will disappear from your file), you may not want to make a partial payment.  If you feel a moral obligation to pay the debt, save the money up and pay it in full.  

What about paying off the debt for less than is owed, in a settlement with the collector?

Every year I have at least one tax client who comes in with a Form 1099-C.  That's the form where a creditor reports to the IRS that they have written off (another term for forgiven) a debt in whole or part.  The result can have tax implications to you.

Example:  If you owe a credit card company $10,000 and they agree to accept a payment of $5,000 as payment in full, you will get a 1099-C for the remaining $5,000.  You will owe income tax on that amount under a theory known as Cancellation of Debt (COD) income.  Because you received the money and wound up not paying it back, the IRS considers it to be income.

Do not despair.  If it turns out that on the date the debt was written off, you were insolvent to the extent of the amount of the debt, then the debt that was canceled will not be subject to income tax.

Example.  In the instance above, the taxpayer has COD income of $5,000.  They have $30,000 in assets and $40,000 in debts on the day the $5,000 in debt was written off.  Since the amount that they are considered to be insolvent ($40K debts - $30K assets = $10K and $10K > $5K), the debt is excluded from income on Form 982.

Can the debt collectors call me all the time?

No.  The link above that takes you to the FTC website explains the rules about how and when collectors can contact you.  You can put a request in writing to a debt collector or agency to stop contacting you.  If they continue to do so after you have made a written request, you have recourse. There are links on the page I linked to above where you can file a complaint against the debt collector.  You can also sue them.

Will the people whose medical debts were forgiven by John Oliver have to pay tax on those amounts?

No.  Because he donated the debts to a non-profit that specializes in forgiving debts, there will be no tax liability.  There is a provision in the Internal Revenue Code that prevents COD income from being subject to taxation when whoever is forgiving the debt is doing so as an act of "detached and disinterested generosity."

Before responding to anyone attempting to collect a debt, explore your rights and if you have a question, seek assistance.  There are consumer protection agencies you can contact.