1099 C and You – Taxation of forgiven debt
Posted by admin on October 1, 2009 under 1099 C, Forgiven debt | 
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Due to unforeseen economical conditions, many people are forced to fall behind on their monthly payments on their credit cards. If the accounts are delinquent for a certain period of time, then the file is sent to some outside collection agency who might use their scary collection tactics to recover the full balance. If someone is not able to pay back the full amount but can afford to pay at least 40% of the original sum, then the collection agencies are willing to work out settlement arrangements. Once the agreed amount is paid off, the original creditor will issue a 1099-C. This is a notice to the IRS of the forgiven debt. The amount of savings more than $600 after the settlement is done is to be shown as an income while filing the taxes. If the debtor does not address this on his return, then the IRS may issue a bill in a year or two with penalties and interests.
If a home has been foreclosed, then the mortgage lender will issue a 1099-C if the property is sold for less than the amount of the loan. In this case, the person not only loses the home but also has to face a tax bill. This bill may come after many months after the tax return was filed as a result of an IRS document matching program. This “under-reporter” notice brings grief to the taxpayer.
If the debtor has declared insolvency, then the savings in the settlement will not be taxable depending on the circumstances. There is an “Insolvency exclusion”. A debtor will fall into this category when his liabilities have exceeded the fair market value of his assets. So it is possible that the amount treated as an income on the forgiven debt is not taxable.
You must show the savings after the debt is forgiven while filing taxes. The issue is whether or not you were solvent at the time of the debt cancellation. You only owe tax on the forgiven debt to the extent you were solvent. For instance, if the forgiven debt was $10,000 but you are only worth $5,000; you would only be liable for income tax on that amount. A home foreclosure is complicated and you may have other legal arguments besides insolvency.
Canceled debt does not need to be shown as an income in the following cases
Bankruptcy – the debts were discharged in bankruptcy through a bankruptcy proceeding.
Insolvency – The total amount of your debts exceeds your total assets at the time your total debts were settled or deemed non-collectible.
Indebtedness is due to a qualified farm expense or due to certain real property business losses.
Debts that got discharged were treated as a gift.
When filing the tax return, you need to explain your insolvency to the IRS. You need to fill out the IRS form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness or attach a detailed letter to your tax return explaining the calculation of your total debts and assets.
You should not be ignoring the 1099-C, otherwise it will result in a tax assessment by the IRS for any amount over $600 plus penalty and interest. This will usually happen after 12-18 months after you file when IRS matches up the info reported to them with what is on your tax return. If you need help, consult a tax professional to do your return and they will figure out how much of the 1099-C is taxable.
If you get a letter from IRS on a 1099-C you left off your return, get help ASAP. Otherwise, IRS might file a Federal Tax Lien and take action. Look for a CPA, Enrolled Agent, Accredited Tax Advisor, Accredited Tax Preparer, or Tax Attorney to help you with serious tax issue. You may call the IRS at 1-800-829-1040 for help as well.
Websites you can check out include: