Debt forgiveness

Debt forgivenessWhen John Oliver announced Sunday night that he’d purchased medical debts as a faux collector and forgiven those debts, the Last Week Tonight host’s actions led to a serious question: Couldn’t this strategy be used on a wide scale? After all, Oliver managed to forgive about $15 million in debt for only $60,000.

It’s a clever idea that has its roots in the Occupy Wall Street movement. Back in 2012, a group calling itself Rolling Jubilee began doing precisely the same thing. It raised money to purchase debts, then told the debtors their bills were forgiven.

While Rolling Jubilee initially focused on medical debt, as Oliver did, the organization now focuses on student loan debt. It claims to have abolished nearly $32 million in debt and raised $700,000.

Oliver actually executed the debt forgiveness by transferring the “paper” to a non-profit named, which was set up to mimic Rolling Jubilee’s strategy, according to the site.

But debt forgiveness using this strategy raises many questions. Chief among them: As Oliver said, his $15 million “giveaway” was really just a drop in the bucket. The Consumer Financial Protection Bureau says that 43 million Americans have an unpaid medical bill on their credit reports. That means Last Week Tonight would have to do roughly 4,777 more episodes to help all those folks.

The Impact on Credit Scores

Debt-buying-and-forgiveness highlights some other interesting issues. As many readers know, the real pain from an unpaid bill isn’t necessarily harassment by a debt collector. It’s often the credit score punishment that follows, which can force a consumer out of typical market transactions. Low credit scores can prevent a consumer from buying a home, a car, or even from getting a credit card.

It’s impossible to say what impact this kind of debt forgiveness would have on an individual consumer’s score — scores are calculated using multiple personal factors. But generally we know that when a debt is marked as settled, or anything other than paid in full, that’s very bad for a score. The negative impact shrinks over time, but it can last seven years. According to this chart from FICO, a settled debt can cause up to a 100-point credit score drop.

We know that the debt Oliver purchased was described on the show as “out-of-state medical debt from Texas,” meaning it was older than that state’s statute of limitations for collection — which in Texas is four years. In that case, the impact from the four-year-old-plus debts may be low, but in many cases, it will still hurt those consumers, even after their debt was “forgiven.”

There’s another silver lining about the debt Oliver purchased: Newer formulas used for credit scores, including FICO 9 and VantageScore 3.0, treat medical debts differently, so that should help some of these consumers, too. Those formulas are slowly making their way through the credit industry.

“Assuming that Mr. Oliver’s debt purchasing company reported these debts as consumer accounts to the credit bureaus, and then updated the accounts to reflect that the debts were ‘satisfied’ (for example, that the outstanding balance was zero), then there could potentially be a positive impact on the FICO Score 9 score,” Ethan Dornhelm, principal scientist at FICO, said in an email. “FICO Score 9 ignores paid collection agency accounts, and it takes a sophisticated approach to differentiating medical from non-medical collection agency accounts. This helps ensure that medical collections have a lower impact on the FICO Score, commensurate with the credit risk they represent.”

But it bears repeating: A forgiven debt does not mean there are no consequences for failing to pay the debt.

Paying Old Debt

The fact that debt-purchases-for-forgiveness often involve out-of-statute debt raises interesting questions as well. Generally, consumers have no legal obligation pay such debt. (The statute of limitations timeframe varies by state.) That’s why it is the “cheapest” form of debt for buyers (including Oliver and Jubilee) to buy. When debt buyers try to collect on it, it’s often called zombie debt, and many consumers are tricked into paying when they don’t have to.

Even a small payment towards the debt restarts the statute of limitations, so any consumer who receives a collector call should immediately identify the age of the debt and the applicable statute of limitations.

When Oliver purchased such debt, he was paying a collector who had no right to collect on it. Rainbow Jubilee faced criticism for making such payments, too, which could be seen as helping fund collectors’ illegitimate activity. And the “relief” offered to indebted consumers was already guaranteed by law.

The Tax Implications

Generally, when a debtor forgives a consumers’ debt — say, through debt settlement — the amount of forgiveness is considered income by the IRS. It’s a real kick in the teeth to consumers, who obviously are in no position to pay income tax on the amount they couldn’t pay to a debt collector. But for now, this is the law.

This is sometimes referred to as the 1099-C problem. Financial institutions must issue 1099-C forms to consumers any time they agree to accept at least $600 less than they are owed, and consumers must “claim” that amount on their tax returns.

When Rainbow Jubilee began its debt purchases, the organization said it had consulted with the IRS and was told there was no 1099-C problem. At the time, not everyone agreed. Writing on the blog, Yves Smith argued that many complex tax issues aren’t settled with the IRS until it makes a formal ruling, and any issues with this kind of novel debt forgiveness were unclear.

While a non-profit may not be required to issue a 1099-C for the “gift” of debt forgiveness, it’s still possible that recipients would have to declare the amount as income. Smith wasn’t saying these consumers had a tax problem, she was merely questioning Jubilee’s certainty that they wouldn’t have one.

On his show, Oliver said that RIPMedicalDebt specialized in debt forgiveness “with no tax consequences.” It is unclear how, however. The organization’s website doesn’t seem to address it. A phone call and an email to the organization were not immediately returned. (Don’t take that as suspicious — the non-profit’s website was down Monday afternoon, no doubt because it was flooded with traffic in the aftermath of Oliver’s segment). Attempts to reach Rainbow Jubilee have been unsuccessful.

An email to Yves Smith about the issue has also gone unanswered. It’s worth noting that we were unable to find any complaints about unexpected tax issues for recipients of this kind of debt forgiveness.

Can’t Target the Benefit 

It’s also worth noting that while buying up debt for pennies on the dollar and forgiving it is definitely good news for the beneficiary, it would be very hard to “target” such debt relief to a particular person. You can’t buy a specific individual’s sold-off debt, for example. The purchases generally involve large spreadsheets with thousands of consumers’ personal information; a good amount of luck would be involved in buying a set of debts that includes a particular person you might be trying to help.

Still, Oliver’s show highlighted many of the absurdities of debt collection, and the alarming practices of some collectors.

This article originally appeared on and was written by Bob Sullivan.