Taxation of Forgivable Loan

[stainedglass80]

If an employer issued a forgivable loan to an employee (say, forgiven in three years if the employee continues working and if not, must be repaid), I had understood that the forgiveness would be included on a Form W-2 at the time of forgiveness and subject to withholding, FICA, etc. at that time.  I also understood that the alternative, if it was not considered a bona fide loan, is that the amount of the loan should have instead been included on a Form W-2 at the time of funding. 

Reading through some of the case law on this it seems like some employers are actually reporting the forgiveness on a Form 1099-C and not a W-2.  Any thoughts or guidance on this front?  I am concerned with the idea of an employer reporting through a 1099-C rather than a Form W-2 but haven't yet found the authorities on this.  Reporting at the time of forgiveness on a W-2 seems a safer approach.

[CuseFan]

https://www.irs.gov/taxtopics/tc431#:~:text=In general%2C if you have,the year the cancellation occurs.

22 hours ago, stainedglass80 said:

Form 1099-C

IRS says 1099-C

[Dare Johnson]

The IRS's current position -  a loan to an employee where forgiveness is contingent on employment is considered compensation at the time the loan is made (loan forgiveness is based on performing personal services).   This would be reported on a W-2.

The employer would receive a deduction at the end of three year window.

See Technical Advice Memorandum 20040004.

[fmsinc]

The TAM cited by Dare Johnson is an outlier. Read  https://www.alvarezandmarsal.com/insights/warning-employee-loans-could-have-adverse-tax-consequences#:~:text=In Technical Advice Memorandum (TAM,the loan%2C for tax purposes.

See the attached Memo that I prepared on this topic a few years ago. 1099-C is the proper instrument to forgive the loan from year to year. 

David 

Empl Forgivable Loans.pdf

[C. B. Zeller]

Maybe this is a silly question - this is outside my area of expertise. From reading the instructions to 1099-C, it appears that it should only be filed if the creditor is a certain financial entity. If the employer is not one of these entities, do they still file 1099-C?

Quote

File Form 1099-C, Cancellation of Debt, for each debtor for whom you canceled a debt owed to you of $600 or more if:

1. You are an entity described under Who Must File, later; and

2. An identifiable event has occurred. It does not matter whether the actual cancellation is on or before the date of the identifiable event. See When Is a Debt Canceled, later.

Quote

Who Must File

File Form 1099-C if you are any of the following.

1. A financial institution described in section 581 or 591(a) (such as a domestic bank, trust company, building and loan association, or savings and loan association).

2. A credit union.

3. Any of the following, its successor, or subunit of one of the following.

   1. Federal Deposit Insurance Corporation.

   2. National Credit Union Administration.

   3. Any other federal executive agency, including government corporations.

   4. Any military department.

   5. U.S. Postal Service.

   6. Postal Rate Commission.

4. A corporation that is a subsidiary of a financial institution or credit union, but only if, because of your affiliation, you are subject to supervision and examination by a federal or state regulatory agency.

5. A federal government agency including:

   1. A department,

   2. An agency,

   3. A court or court administrative office, or

   4. An instrumentality in the judicial or legislative branch of the government.

6. Any organization whose significant trade or business is the lending of money, such as a finance company or credit card company (whether or not affiliated with a financial institution). The lending of money is a significant trade or business if money is lent on a regular and continuing basis. Regulations section 1.6050P-2(b) lists three safe harbors under which reporting may not be required for the current year. See Safe harbor rules next.

 

[stainedglass80]

I read Rev. Rul. 2004-37 to suggest that the forgiveness should be included in income, with the employer required to deduct and withhold, at the time forgiven (assuming it was not compensation when first paid) but it is not clear whether that is just because of the interaction with 83 or whether it is more generally because (as described in 2004-37) "the reduction of the stated principal amount is a medium for payment of compensation by Employer to Employee" not subject to 108.

[EBECatty]

I'm with C.B. Zeller and stainedglass on this one. fmsinc, your memo says forgiveness is reported on Form 1099-C but does not provide a cite for that position. The link you provide does not mention a Form 1099-C either. 

Although it's frustratingly difficult to find a clear statement, Rev. Rul. 2004-37 says:

Not every indebtedness that is cancelled results in the debtor realizing gross income by reason of discharge of indebtedness within the meaning of sections 61(a)(12) and 108(a). “Debt discharge that is only a medium for some other form of payment, such as a gift or salary, is treated as that form of payment, rather than under the debt discharge rules.” S. Rep. No. 1035, 96th Cong., 2d Sess. 8 n.6 (1980), 1980-2 C.B. 620, 624 n.6.

The Bloomberg BNA portfolio takes the position that cancellation of an employee loan is compensation, citing Rev. Rul. 69-465, which also states that an employer's forgiveness of an employee's loan is "compensation" although it doesn't specify where to report. 

As C.B. Zeller notes, a typical employer-employee relationship would not seem to fall under any category of "Who Must File" a Form 1099-C. 

To the extent the employer is not reporting or paying FICA on the forgiveness, I'm not sure how that position would be tenable either.

Would be interested to see any guidance to the contrary.