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John Oliver made news a few months ago by purchasing nearly $15 million in outstanding medical bill debt for $60,000 -- less than a penny on the dollar.

But, I read that cancellation-of-debt ("COD") is taxable income. How Oliver got around this ("...no tax consequences whatsoever...") seems odd...

Oliver set up a dummy corporation ("CARP") and then as CEO of CARP, he negotiated the debt purchase (presumably from some other collection agency).

But, rather than forgive the debt directly, CARP turned around and donated the debt to RIP, a charitable organization.

Am I to understand that this second transfer was necessary in order to explicitly avoid the tax consequence of COD? I do understand that COD is taxable income, but "gifts" are not.

CARP is a simple $50 setup-fee LLC (and presumably not a charitable organization), whereas RIP was/is an established 501(c)(3) charity.

I'm assuming that Once CARP purchased the debt, it then had rights of ownership with respect to debt collection, i.e. it could (1) continue pursuing collections from the debtors, (2) do nothing with the debt, (3) forgive the debts individually or en masse, or (4) donate it to a charity (which is what it did). After CARP gave (donated) the debt to RIP, then RIP was free to forgive the debts (which is its explicitly-stated mission).

Had CARP pursued option (3) above, then does that mean all that forgiven debt was/is taxable income as COD?

ADDENDUM:

I just now realized that, in a theoretical situation where CARP chose option (1) -- attempt to collect on the debt. Pretending that CARP successfully collected e.g. $1 million, is this simply money that CARP can keep? (Subject to corporate income tax, of course.)

I'm also assuming that "purchasing" debt gives the purchaser rights of ownership such that any collected money from a debtor cannot be further claimed by previous creditors. Is this indeed the case?

  • For that matter, if this trick really works, it seems like nobody ever needs to pay income tax on cancelled debt again: just ask the creditor to donate your debt instead of cancelling it. Seems like a suspiciously big loophole. – Nate Eldredge Aug 23 '16 at 0:59
  • While I think this is an interesting topic, I'm having a hard time picking out one question here to answer. I see "was the second transfer necessary?", "if CARP pursued option 3 out of 4, is it taxable income?", "can CARP keep money?", and "does purchasing debt prevent previous creditors from collecting". Those are all interesting questions, but Stack Exchange works best if you have one question to answer and create new questions for the others. – Thunderforge Aug 23 '16 at 0:59
  • The answer to the last question is surely yes - that is the whole point of purchasing debt, so that the buyer can collect instead of the seller. It would be nonsensical if this caused the amount of the debt to double. – Nate Eldredge Aug 23 '16 at 1:02
  • @NateEldredge: That was my thought, too. But, as mentioned in the various articles I linked, the level of indebtedness presumes that the debtors are in dire straits financially--they don't appear to be "gaming" the system. – pr1268 Aug 23 '16 at 1:20
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    @NateEldredge "just ask the creditor to donate the debt" if I do that I may have a charitable donation (if every one agrees the value is the basis instead of the true zero value) but i dont see how to claim the loss as an operating cost. And if I'm sending you a 1099-C I am unlikely to take steps to reduce your tax on account of your asking. – user662852 Aug 23 '16 at 17:00
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Oliver or his shell corporation could have directly forgiven the debt as a gift to the debtors. As a gift, it would not have to be reported as income, according to the IRS. In that case, he would need to file Form 709 and he would have to pay federal gift tax. There is an annual exclusion of $14,000 per donee, which probably is a drop in the bucket. It may not be required to pay tax on gifts to a 501(c)(3) organization, since the gift-bump is offset by the associated charitable gift deduction. The charity can then forgive the debt as a gift (and as tax-exempt, would not have to pay gift tax). In that sense, the second transfer was necessary, although it would not have been if RIP had directly obtained the debt (or if CARP were a 503(c)(3)).

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