On May 5, 2017 a U.S. federal magistrate judge in Wisconsin dismissed a Fair Debt Collection Practices Act (FDCPA) putative class action regarding 1099(c) language in a settlement letter. The case is Dunbar v. Kohn Law Firm SC (Case No. 17-cv-88, U.S. District Court, ED, WI).

A copy of the court’s Decision and Order can be found here


On January 29, 2016, Kohn Law Firm SC (Kohn) send Plaintiff, Mary Dunbar, a debt collection letter on behalf of Midland Funding LLC. The letter stated that the amount owed was $4,049.08 but offered to settle the debt for $2,631.90. The letter also stated, “NOTICE: This settlement may have tax consequences.” 

Dunbar filed a lawsuit on January 19, 2017, alleging violations of the FDCPA. According to Dunbar’s complaint: “Referring to tax consequences in a collection letter is intimidating and misleading, suggesting to the unsophisticated consumer that failure to pay the debt will give rise to problems with the Internal Revenue Service (IRS).” She asserted it suggests that, “[u]nless the consumer pays the entire amount that the defendant alleges is owed on the alleged debt, the consumer could be reported to the IRS” and “[u]nless the consumer pays the entire amount the letter alleges is owed for the debt, the consumer is going to have to pay taxes on the unpaid balance.” She further alleged that there are various ways under the Internal Revenue Code (IRC) by which a person may discharge a significant debt without it resulting in “tax consequences.” For example, if the debtor is insolvent, no taxable income results from discharge. Also, reporting is not required of the discharge of a debt that constitutes interest or other non-principal or of the discharge of principal of not more than $600.” 

Dunbar alleged that the defendants “violated 15 U.S.C. §§ 1692e, 1692e(2) and 1692e(10) by representing in [the letter] that ‘This settlement may have tax consequences.’”

On February 14, 2017, the defendants in the case, Encore Capital Group Inc., Kohn Law Firm SC, Midland Credit Management Inc., and Midland Funding LLC, moved to dismiss Dunbar’s complaint. Dunbar filed an amended complaint on March 7, 2017, and the defendants moved to dismiss it on March 21, 2017.

Dunbar responded to the second motion to dismiss and the defendants replied. The court determined the motion was ready for resolution. All parties consented to the full jurisdiction of a magistrate judge.

The Court’s Opinion

Magistrate Judge William E. Duffin issued the Decision and Order. He began his analysis with a review of the IRC rules on discharge or forgiveness of a debt. He wrote:

“The discharge of a debt constitutes gross income under the Internal Revenue Code. 26 U.S.C. § 61(a)(12). If the discharge is of $600 or more, the discharging entity must file a 1099-C with the IRS. 26 U.S.C. § 6050P; 26 C.F.R. § 1.6050P-1. Regardless of whether the creditor is required to report the discharge by way of a 1099-C, the debtor may be required to report the discharge as income.” 

In the amended complaint Dunbar cited four cases where “misrepresentation of a debtor’s rights or liabilities under the Internal Revenue Code in connection with the collection of a debt was found to be an FDCPA violation.” 

Judge Duffin found the current case distinguishable from all four cited cases. Duffin concluded:   

“In each of the cases cited by Dunbar in her amended complaint the debt collector represented something as being certain to happen when it was merely a possibility. In contrast, the letter sent to Dunbar stated only that a “settlement may have tax consequences[.]” Emphasis added by the court. 

In considering the challenge regarding tax consequences of debt forgiveness Judge Duffing noted that there were numerous cases where debt collectors have been sued under the FDCPA for not stating that a settlement might have tax consequences. He noted: 

“Given the number of debt collectors who have been sued for not mentioning the potential tax consequences of a settlement, it is not surprising that some debt collectors choose to mention potential tax consequences in the letters they send to debtors. As indicated above, early efforts at including such language sometimes backfired when courts found the notices plausibly misleading because the debt collector failed to account for certain exceptions or chose to provide information that an unsophisticated debtor could find misleading.” 

Judge Duffin was more persuaded by two recent cases where courts have approved statements similar to the statement at issue in this case. Those two cases were Everett v. Financial Recovery Services, Inc., 2016 (Case No. 16-01806, U.S. District Court, S.D. Ind., Nov. 28, 2016) and Remington v. Financial Recovery Services, Inc., 2017 (Case No. 3:16-865, U.S. District Court, D. Conn., Mar. 15, 2017). insideARM wrote about Everett on January 11, 2017 and Remington on March 20, 2017. 

Duffin determined:

“The defendants accurately informed Dunbar that there may be tax consequences if she settled her debt for less than the amount owed. Accepting Dunbar’s allegations in her amended complaint as true, the fact that her circumstances were such that she would not actually realize any tax consequences does not render the defendants’ statement misleading. The statement was phrased contingently and encompassed situations where tax consequences would not result. As the court in Remington noted, even an unsophisticated debtor would not read “may” as “will.” 

Rather than being plausibly intimidating, the court finds the statement more likely to be helpful. The court agrees with those courts that have found that no such statement is required when proposing to settle a debt, but nonetheless finds that a debt collector who chooses to include such a statement has not violated the FDCPA. An unsophisticated debtor might not recognize that the discharge of a debt constitutes income and therefore might have tax consequences. Taxes are complicated. Absent being alerted that a settlement might affect her taxes, a debtor might mistakenly believe that her net savings by accepting a settlement will be greater than they actually turn out to be.

A debtor who reads, “This settlement may have tax consequences,” might reasonably have questions about what that means for her. But that is the point of the statement. It is intended to alert the debtor that there is an issue that she ought to consider when deciding whether to accept the proposed settlement. That is not misleading or deceptive. The court finds that it would take a bizarre and idiosyncratic reading for even an unsophisticated debtor to conclude that, in light of some potential unknown “tax consequences,” she had better pay the entire debt rather than accept the proposed settlement.”

insideARM Perspective 

This case is positive for the ARM industry. But the issue is far from resolved throughout the country. Tax consequences of debt settlement is the classic “Catch 22” for debt collectors. Mention tax consequences and get sued. Don’t mention tax consequences and get sued. 

It would be helpful if the IRS and the CFPB would come together and jointly issue rules governing the issue. From a third-party agency perspective, perhaps the best solution would be a specific requirement that the OWNER of the debt is the only entity required and allowed to make the disclosure. That would eliminate these lawsuits in the future for the pure third-party debt collector. 

In the past, many credit grantor clients have required third party agencies to make 1099(c) disclosures in communications with consumers. Those disclosures lead to lawsuits. As noted above, opinions from various courts have not been consistent. For a review of several such cases see the insideARM FDCPA resources page. 

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