Although not every settlement agreement has to be reviewed by a tax lawyer if you are representing a creditor or a debtor and the subject matter of the settlement involves the compromise of a debt or a cancellation of an indebtedness, there are some basic tax matters which must be considered.
If you are representing the creditor, you should consider whether the cancellation or compromise of the debt will be deemed income for tax purposes. This consideration will lead to a determination of whether the creditor must issue a Form 1099-C to the IRS and to the debtor.
If you are representing the debtor, you must consider whether the settlement qualifies as a contested liability dispute. If the debtor-taxpayer, in good faith, disputes the liability of the obligation, then a subsequent settlement of the disputed debt may not result in income, and thus, the creditor would not have to issue a Form 1099-C.
The recent Sixth Circuit case of McClusky v. Century Bank, FSB, 2015 U.S. App. LEXIS 1419 (2015) concerns the consequences of failing to consider possible tax issues, and provides an excellent summary of the law applicable to the settlement of a dispute involving the cancellation or …