It has long been clear that a taxpayer's gross income includes income from the discharge of indebtedness,1 but for many years the Internal Revenue Code (the Code) did not require lenders to file information returns with respect to discharged debt. In order to encourage taxpayer compliance with respect to discharged indebtedness and to enhance the ability of the Internal Revenue Service to enforce the discharge of indebtedness rules,2 Congress amended the Code in 1993 to require that an "applicable financial entity," such as a bank, domestic building and loan association, or credit union,3 that "discharges" the debt of any person must file an information return with the IRS and provide a written statement to the person whose debt was discharged. Significant civil penalties, ranging up to 20 percent of the amount of indebtedness discharged, may be imposed on an applicable financial entity that intentionally disregards the information reporting requirements.4
Treasury regulations provide that, "[s]olely for purposes of" these information reporting rules, indebtedness is "discharged" not only on the date of various events of cancellation or extinguishment arising in a judicial proceeding or by agreement between the creditor and the debtor, but also upon "a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt."5 Moreover, a rebuttable presumption arises that debt has been discharged for these purposes "if a creditor has not received a payment on an indebtedness at any time during a [36-month] testing period…ending at the close of the year."6
