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In NY there is no statute of limitation on collection efforts. The only statute of limitation would exist on the claim (as you pointed) or on the judgment. So as far as collections go, they can continue to try and collect on the money that is allegedly owed (of course doing it within the collection legal guidelines) and you can choose to ignore them
As far as removing the negative credit reference you can only do it directly with the credit agencies. The reality is even if you settle the matter there will still be a record the claim against you. So you should pursue the matter directly with them and indicate that either the matter has been wrongfully placed in collections and therefore it wrongfully appears on the credit report.
Bear in mind that the credit agencies have limited resources and/or limited documentation in connection with the original claim against you, so the more you provide to them to support your position the better the chances you will have to have it addressed.
Finally, if the matter still does not show up on your credit report and the collection agency does not have your social security number then under the Fair Credit Reporting Act (FCRA) §605 the clock begins ticking approximately 180 days after the date of first delinquency on the account and the report can only go back 7 years to that initial date. So the credit report can only contain information that is 7 1/2 years old . Subsequent activity, such as resolving the debt, is irrelevant to the 7 year rule.
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If I do not settle with this company, what do I do if they send me a 1099? I think they can send it to me so I pay taxes on it and they then can write off the debt. Is this true?
The issue of a 1099c should be a separate question in it of itself. It actually brings up fairly complicated statute of limitation issues intertwined with tax issues. I would not worry about it until you actually receive a 1099. FCRA as well various IRS rules and the IRS' statute of limitation of 7 years would then be evoked to deal with this.
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