Banking and Finance Law Daily Statement that debt settlement 'may have tax consequences' not misleading
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Monday, July 23, 2018

Statement that debt settlement 'may have tax consequences' not misleading

By Nicole D. Prysby, J.D.

The tax consequences warning in debt collection letters sent to insolvent debtors was literally true and not misleading under the Fair Debt Collection Practices Act where the letters stated that a settlement "may have tax consequences," held the U.S. Court of Appeals for the Seventh Circuit. The court rejected the consumers’ argument that the statement could be read to mean that they would be reported to the IRS for failing to pay the entire debt or that the statement was misleading because insolvent debtors would have no tax consequences. Although insolvent debtors may have no tax consequences, the word "may" did not mean "will" and a debtor may become solvent before settling a debt, so it was not misleading to say that a debt settlement "may" have tax consequences. The letters also did not give a false impression that the debtors were required to pay the entire debt to avoid tax liability. The letters were meant to encourage the debtors to settle the claims, and a rational debtor would know that even if the discount is a taxable benefit, the benefit would still outweigh the cost (Dunbar v. Kohn Law Firm, S.C., et al. and Smith v. Weltman, Weinberg & Reis Company LPA, July 19, 2018, Sykes, D.).

The court considered whether an objective, unsophisticated consumer would have been deceived by the statement and concluded that there was no misrepresentation. In the first place, the statement is literally true: discharge of a debt is considered taxable income. Although a literally-true statement may be misleading if it gives a false impression, this statement did not. The consumers argued that the statement could be read to mean that the debt collector would report the debtor to the IRS if the debtor failed to pay the full balance owed. But the letter said nothing whatsoever about IRS reporting.

The court also rejected the consumers’ argument that the statement could be read to mean that the debtor could incur a tax liability, which is contextually misleading because most recipients of debt-collection letter are insolvent; even an unsophisticated consumer would not read "may" to mean "will." The letter also did not give the false impression that debtors should pay their entire debt to avoid a tax liability. The letters were invitations to settle a debt, clearly intended to encourage the debtors to take advantage of the discount offered. A rational debtor would know that income tax is calculated as a percentage of income, and would understand that even if the discount is a taxable benefit, the benefit would still outweigh the cost.

The court also pointed out that solvency is fluid. A debtor may become solvent before settling a debt, so it was not misleading to say that a debt settlement may have tax consequences. And, the court noted, debt collectors do not have any reason to know whether a particular debtor is solvent or insolvent at a given time.

The cases are Nos. 17-2134 & 17-2165.

Attorneys: Daniel A. Edelman (Edelman Combs Latturner & Goodwin, LLC) for Amy Dunbar. David M. Schultz (Hinshaw & Culbertson LLP) for Kohn Law Firm, S.C., Midland Funding, LLC, Midland Credit Management, Inc. and Encore Capital Group Inc.

Companies: Kohn Law Firm, S.C.; Midland Funding, LLC; Midland Credit Management, Inc.; Encore Capital Group Inc.

MainStory: TopStory DebtCollection EnforcementActions

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