The Serious Tax Questions Behind Strike Debt’s Rolling Jubilee
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I haven’t heard too much from the Rolling Jubilee, Occupy Wall Street’s idea to cancel debt after purchasing it from collectors, since the initial announcement. But Yves Smith is absolutely right to address this threat of potentially making things worse for the borrowers the Rolling Jubilee (under the name Strike Debt) means to help. It all comes back to debt forgiveness and federal tax policy.
To review: normally, the cancellation of indebtedness is treated as income unless the party is in bankruptcy or can establish that they are insolvent. Strike Debt claims they do not need to issue 1099-Cs, the usually-required notification to the IRS that debt has been forgiven. They further claim that they have “double checked” with the IRS on this matter. In addition, Strike Debt is conducting its activities through a 501 (c)(4), which is a form of tax exempt organization (a “Civic League and Social Welfare Organization”). As we will also discuss, its debt forgiveness plan also appears to run afoul of the IRS’s published requirements for a 501 (c)(4).
Yves goes on to explain that the “double-checking” means almost nothing without an actual ruling from the IRS. And the IRS has not issued that ruling, as they stated specifically in their 2012 “no ruling” list. The double-checking involved in ringing up the IRS call center really doesn’t count as a final ruling on this point. The IRS MAY determine that the cancellation of debt through the Rolling Jubilee counts as a gift. Or they may determine that the borrower granted the relief owes taxes on the earned income gained from the cancelled debt. In any case, Strike Debt can only find out whether or not they need to issue a 1099-C, not whether or not the party with the cancelled debt is liable for relief. Even without a form issued, the debtor could find themselves liable. This is from a tax attorney:
Now, this isn’t the end of the story in my mind–the form is just a form, and the IRS is very clear on that same page that COD [cancellation of debt] income is owed even if no form is required, just like you still have to pay tax on income even if you (for various reasons) never got a 1099-DIV/INT/etc. In fact, if there is COD income but no form, I’d actually be *more* pissed at Strike Debt, because they imply (but do not legally state) that there is no COD income, thus leaving the COD cancellation recipients hanging in the wind when the IRS comes tapping on audit (the argument “I saw it on an Occupy website and that’s why I didn’t pay taxes” has exactly zero legal bearing on audit).
Moreover, the first time that the borrower will probably hear from ANYONE about their cancelled debt will be from the IRS. It will be extremely difficult for Strike Debt to determine who received their largesse, as they will purchase the debt blind. The IRS generally does not consider middle-class borrowers as eligible for debt relief – they only exempt debt cancellation as income when the borrower is insolvent – and Strike Debt will not really know the financial status of their beneficiaries.
Maybe the IRS won’t bother with a negligible amount of debt. But this is a fairly high-profile program, and Strike Debt simply cannot say with much degree of certainty whether or not the IRS will see things their way. Heck, they may go after Strike Debt simply because it’s using a 501 (c) (4) “social welfare organization” tax status:
From the IRS discussion of 501 (c)(4)s:
To qualify for exemption under section 501(c)(4), the organization’s net earnings must be devoted only to charitable, educational, or recreational purposes. In addition, no part of the organization’s net earnings can inure to the benefit of any private shareholder or individual.
Forgiving someone’s debt could be a violation of the private benefit rule. Middle class debtors are not a charitable class.
This is a more serious problem than I think people recognize. Strike Debt has a noble function at its core, to relieve indebted borrowers. But the IRS questions are thorny, and could end up in a situation where the borrower is hurt more than helped by the cancellation of debt. What’s more, instead of breaking down the private debt collection industry, this would legitimize it, as Strike Debt would be using the private debt markets to purchase the debt. The debt collection industry is among the worst in America, and it’s not clear whether or not they would be aided and abetted through more competition. Strike Debt has some other great ideas to help debtors resist their creditors, like the Debt Resistors’ Operations Manual, that would actually serve to break down the debt collection industry by empowering debtors with the knowledge to beat them in court. That sounds like a much better option.
Maybe there are ways around this, maybe not. But it’s worth verifying rather than trusting Strike Debt with a potentially dangerous plan that could hurt the people they want to help.