A Collection Agency Sent Me a 1099 MISC Tax Form, Now What?

For collection agencies, tax time is the best time of year to collect. Tax season brings with it extra cash for millions of Americans, and its no great feat for a debt collector to scare that cash right out of a debtor's wallet. For some, however, tax time also brings a 1099 MISC from the collection agency. This means trouble.

What is a 1099 MISC From a Debt Collector?

You have to include your 1099 debt when you file taxes

All business have the right to write off bad debt as a loss at the end of the tax year. Collection agencies are no exception. If the collector considers your debt uncollectable, it will claim that debt as a loss and send you a 1099 MISC form. The 1099 serves two purposes: it notifies you that the debt has been written off as a loss and it also notifies you that the IRS is aware of it.

Those with outstanding debts aren't the only ones who might discover they're subject to a collection agency's 1099. If you paid a settlement to a collector, the collector has the right to claim the unpaid portion of the debt – the portion is supposedly "forgave" – as a tax loss. And there's that 1099 again.

The law says that when you receive a 1099 for bad debt, you must claim the debt as income when you file your taxes. Not only could this cut into your tax refund, it could leave you owing the IRS. The collection agency doesn't have to pay taxes on the bad debt because it constitutes a business loss, but somebody has to pay. In this case, that somebody is you.

A 1099 Doesn't Stop Collection Activity

For many debtors, worn down by aggressive debt collectors, a 1099 is a sigh of relief. They'll include it in their income, pay taxes on it and then it will disappear. Gone. Poof. Freedom. Right? Welll...no.

As ludicrous as it sounds, the collection agency has the legal right to continue attempting to collect the debt, even after claiming your account as a tax loss. Whether or not you've paid taxes to the IRS on the debt is of no consequence to the collector. Should the collection agency successfully collect the debt, it must report this fact to the IRS and pay taxes on the money. Neither the collection agency nor the IRS will refund the tax you paid after receiving the 1099 form.

This sounds so unfair that few people are willing to accept it. Those with some legal knowledge will often argue that the Code of Federal Regulations prohibits businesses from selling a debt or continuing collection activity after sending the consumer a 1099 and writing off the account as a loss. And that's true – if you happen to be a corporation. This regulation only applies to business debt, not private consumer debt. When it comes to debt owed by private individuals, the collector can continue collection activity without restriction. It can even sell your debt to another debt collector.

What Do I Do When I Get a 1099 From a Collection Agency?

I wish I had better news for you but, in this case, the best thing to do is to grit your teeth and pay the piper. The IRS is a whole heck of a lot more dangerous than even the most aggressive collection agency. In the event of an audit, the IRS can and will slap you with a whole host of fees should you "overlook" income (even though the debt is clearly not income, the IRS doesn't see things that way). It's crucial to keep records of the 1099 and the fact that you paid taxes on it, lest another debt collection agency send you a 1099 in the future for the same debt.

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