To Forgive Is Divine (Then Comes the Tax Bill)by
The people who brought you Occupy Wall Street have come up with an extremely clever idea: raising money to buy random citizens’ overdue debt, and then—poof!—forgive it. One day a debtor is fielding calls from a collection agency; the next day, she’s not.
If this vanishing act sounds too good to be true—and it might be, but we’ll get to that—it helps to start at the beginning. Debt is easiest to think about as a negative thing: It’s money you owe somebody. From that somebody’s perspective, though, debt is money coming due. That makes it an asset that can be bought and sold—at a discount based on the likelihood it will be repaid.
When debt becomes overdue, it gets cheaper, and when it becomes really overdue, it sells for pennies on the dollar. Whoever buys debt can do whatever they like with it—including forgive it. That’s the idea that Strike Debt, a group that grew out of the Occupy Wall Street movement, says it will put into practice with a project it calls the Rolling Jubilee. For every dollar contributed, the group expects to be able to buy and forgive $20 of distressed debt.
David Rees, a humorist best known for his Get Your War On comic and How to Sharpen Pencils book, wrote on his blog that Strike Debt has successfully tested the idea with a $500 purchase of $14,000 in debt, a ratio of 1 to 28. “Now, after many consultations with attorneys, the IRS, and our moles in the debt-brokerage world, we are ready to take the Rolling Jubilee program LIVE and NATIONWIDE,” Rees wrote, “buying debt in communities that have been struggling during the recession.” Strike Debt is advertising the effort as “a buyout of the people, by the people.”
It’s a laudable idea—although the $1 million target Strike Debt has floated amounts to a drop in the bucket of American consumers’ overall indebtedness, which stood at $11.38 trillion as of June 30, according (PDF) to the Federal Reserve Bank of New York. (That’s actually a generous comparison, given standard measurements of drops and buckets.) So if this is a people’s bailout, it’s a symbolic one, dwarfed by the lifelines that major financial institutions got during the crisis.
Slate’s Matthew Yglesias quibbles that the Rolling Jubilee benefits people who have racked up debt while it ignores those who are simply poor. “Given two struggling families, one of which is indebted and one of which isn’t, it’s not clear why you’d think that the family that’s borrowed heavily in the past is more worthy of assistance,” he writes. “And similarly, for any particular indebted family it’s not obvious that on a dollar-per-dollar basis debt forgiveness is more helpful than just handing over some cash.”
This is all nitpicking, though, compared with the big, inevitable catch: taxes. A person’s debt can’t truly disappear with no consequences. The amount forgiven is technically income—“cancellation of debt income,” in Internal Revenue Service terms. It’s a dollar-for-dollar conversion, says Robert Willens, a tax expert based in New York. For example, a person with regular income of $50,000 who has $25,000 in credit-card debt discharged will be taxed on April 15 as if she earns $75,000.
“There’s not any doubt about the tax outcome at all,” says Willens. “That’s almost always the case with debt discharges—you wind up with this tax problem that almost always mitigates the benefit of the discharge.”
There are exceptions—such as when the taxpayer is insolvent, in which case taxes are only due on the amount of the forgiveness that exceeds her insolvency, says David Miller, a tax attorney at Cadwalader, Wickersham & Taft. Bankruptcy is another exception.
Strike Debt didn’t make a representative available for an interview despite several requests, so I wasn’t able to ask about the particulars of who the group plans to buy debt from, or about its legal structure. Miller suggests that the group form a 501(c)3 organization that negotiates directly with credit-card companies on behalf of individual debtors and structures its payments as grants. Solvent people would still owe tax, but donors to the cause would be able to get a tax deduction. (Strike Debt, if you’re reading, Miller says he is happy to help you set up this structure pro bono.)
Credit scores also go down when debt is written off, as opposed to repaid.
David Graeber, whom Bloomberg Businessweek profiled as “the anti-leader of Occupy Wall Street” in an October 2011 cover story, wrote about the concept of jubilees in his book Debt: The First 5,000 Years. They’re rare today, but in ancient Babylon, Assyria, and Egypt, rulers regularly forgave their subjects’ debt during lean years as a means of staving off revolt.
A fundraiser to kick off the Rolling Jubilee is scheduled for Nov. 15 in New York, featuring Janeane Garofalo, Max Silvestri, Jeff Mangum, Tunde Adebimpe, and other artists. The cheapest ticket goes for $25 (enough to erase $500 in debt).
UPDATE, Nov. 13, 3:20 p.m.: Strike Debt has now posted a FAQ, which offers some more detail on its operations. The group says it’s a 501(c)(4) organization, buying anonymous accounts that are bundled together, with little information about their owners. As for taxes: “The Rolling Jubilee will earn no income from the lending of money and is therefore exempt from filing a Form 1099-C under the Internal Revenue Code Section 6050P.” The page is silent, though, on what the debtors’ tax responsibilities are.
Strike Debt is still declining interview requests. Willens and Miller, contacted again, say that even if the group does not file a 1099-C, a debtor must still declare the forgiven debt as income: the missing form just makes it more difficult for the IRS to enforce its rule.
Felix Salmon of Reuters and Tim Worstall at Forbes have written that the Rolling Jubilee’s lucky beneficiaries won’t owe any tax because the forgiveness qualifies as a gift. I asked Willens and Miller for their take. Miller was unequivocal: “The amount that is paid the credit card company is a gift. The COD income is not.”
Willens, after reading aloud for several minutes from the tax code and the 1960 Supreme Court ruling in Commissioner v. Duberstein, said the gift strategy may work — emphasis on may. “It is certainly not free from doubt. Far from it,” he says. “The burden of proof would be on the parties to establish it’s a gift — and the overwhelming presumption is that it would be income.” Because the definition of gift is such a woolly issue, he says, the best course is for Strike Debt to simply ask the IRS for a ruling on the matter.