As readers of my articles know, unresolved debt is the number one reason for security clearance denial. In many cases, however, what passes for resolution in the civil law context is insufficient in the world of national security. Security clearance applicants are sometimes shocked to discover that debt which a civil attorney or credit counselor told them was “unenforceable”, “time-barred”, or “charged-off” is still at issue in security clearance denial proceedings
If this sounds like you, understand that you generally have three options: pay the debt, settle it for less than the full amount owed, or dispute it in good faith and following established procedures. But before you do any of that, there is one crucial step you shouldn’t overlook: a review of your tax records.
Many people are unaware of the fact that a discharge of legally forgiven debt is actually a taxable event. In other words, if you owe someone money and the debt is forgiven, you are generally required to treat the forgiven debt amount as income, report it on your tax return, and pay taxes on that amount in the year in which it was forgiven. Financial institutions that “charge off” debt often issue a 1099-C (Discharge of Debt) form to the debtor, which is then used by the debtor or his/her accountant for tax reporting purposes. If you received such a form – and paid the requisite taxes due in the given year – all federal agencies of which I am aware will treat the 1099-C form as dispositive proof that the debt is resolved. Merely presenting a credit report showing the debt was “charged off” is insufficient because a “charge off” without a 1099-C issued technically renders the debt still enforceable.
In most repossessions or foreclosures, the lender subsequently sells the repossessed/foreclosed upon property at a loss, resulting in a “deficiency” for which the debtor may be liable. Yet in rare cases, a secured lender (e.g. a mortgage lender or an automobile lender) will foreclose on or repossess property then re-sell it at a profit. This is the case where, for example, the debtor has paid off the majority of his or her loan, leaving the lender with positive equity after re-sale. If that happens, the lender is required to issue a 1099-A form that evidences the foreclosure or repossession but makes clear that no deficiency occurred as a result. The debtor owes no taxes because – while the debtor’s remaining debt was technically forgiven – the debtor actually came out on the losing end of the transaction. If you received a 1099-A, this document is generally dispositive proof the debt at issue was resolved.
Summing It Up
The key issue in the eyes of security clearance adjudicators is whether you have acted responsibly and reasonably in your financial life – such that you should be trusted to follow the rules surrounding protection of classified information. A long trail of 1099 forms is probably not going to help your case. But if the reason for your security clearance denial is a single debt (e.g. a foreclosure) or even a few debts, a 1099-C or 1099-A form may be your golden ticket – and another reason to keep your tax paperwork in a safe place!
This article is intended as general information only and should not be construed as legal advice. Consult an attorney regarding your specific situation.
 You may not owe taxes if the discharged debt was the result of a foreclosure on a principal residence. Consult a CPA or tax attorney for guidance.