Ca. Tax Lawyer Summer 2014, Volume 23, Number 2

A Proposal for Modifying the 36-Month Rule Imposed by Treasury Regulation Section 1.6050P-1(b)(2)(ii)(H)

By George Zbylut1


Since its promulgation in 1996, section 1.6050P-1(b)(2)(ii) (H) of the Treasury Regulations has caused confusion. On the one hand, the 36-month provision provided for by Treasury Regulation section 1.6050P-1(b)(2)(ii) and (iv) provides a line of demarcation for creditors and borrowers and a point of certainty for the recognition of income. On the other hand, the phrase ‘significant, bona fide collection activity’ in Treasury Regulation section 1.6050P-1(b)(2)(iv) has long clouded what should be a clear directive. What constitutes ‘significant, bona fide collection activity’? The ability of the Internal Revenue Service ("IRS") to successfully tax cancellation of debt income depends upon the answer.

Statistically, a creditor’s likelihood of collection of a delinquent debt drops dramatically after 90 days. By the two year mark, the likelihood of collection has fallen to under ten percent. Recognizing this, collection agencies charge considerably higher fees for older debts or, for those that buy debt, pay a significantly lower price for such debt. At some point, the creditor will decide the debt is uncollectable and simply ‘charge off’ the debt, removing it from their books. Prior to reaching this conclusion, the creditor may cease collection attempts. In order to avoid a long lag time, during which the IRS may lose its ability to tax the income, Congress developed a 36-month rule.

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