1099-C Cancellation of Debt Form and Tax Consequences
When an individual has debt cancelled or forgiven through the debt settlement process, there are obvious benefits. Simply put, the amount of money owed has been reduced, as debt settlement occurs when a debtor successfully negotiates a payoff amount for less than the total debt owed.
However, there often are tax consequences to debt settlement, as the IRS requires that cancelled debt of $600 or greater must be treated as taxable income on Form 1099-C “Cancellation of Debt” when filing income tax the following year. Form 1099-C reports a debt that has been cancelled through debt settlement, forgiven by a creditor or discharged in a bankruptcy proceeding. Let’s take a closer look.
When a debt in the amount of at least $600 is forgiven or cancelled, the IRS requires the creditor to send the debtor a 1099-C Cancellation of Debt tax form that stipulates the amount of the cancelled debt.
However, current tax law still does not require businesses to inform debtors of the tax consequences of debt settlement, and, as a result, many of the approximate 4.3 million consumers who receive a 1099-C each year underestimate or ignore its importance when filing their income tax.
In fact, because many 1099-C forms are sent by the same debt collector with whom the debtor successfully settled, the 1099-C often gets discarded under the assumption that it is irrelevant and outdated.
Unfortunately, nothing could be further from the truth, as the IRS will also receive a copy of the 1099-C. The 1099-C form must be completed and sent when filing taxes – and though there are exceptions – there will usually be a tax bill associated with the 1099-C.
Why Did I Receive A Form 1099-C?
Form 1099-C will be sent following an instance in which a debt has been cancelled, forgiven or discharged. When a portion of unsecured credit card debt is cancelled through the debt settlement process, this will trigger the sending of a 1099-C form prior to the next tax reporting season.
Other instances that will trigger the sending of Form 1099-C include automobile repossession, home foreclosure, abandonment of property, return of property to a lender, and a refinancing or modification to a loan related to a primary residence.
Mortgage Forgiveness Debt Relief Act
The good news is that there are exceptions as to when a tax liability results from cancelled debt and Form 1099-C. For example, following the burst of the real estate bubble and housing crisis that included a sharp drop in real estate values, Congress passed the 2007 Mortgage Forgiveness Debt Relief Act.
The Act covers the calendar years 2007-2017 and allows for the exclusion of up to $2 million in forgiven mortgage debt for joint income tax filers and for the exclusion of up to $1 million in forgiven mortgage debt for individual tax filers.
Mortgage debt forgiven through a mortgage restructuring or in connection to a foreclosure is also covered under the Act. Mortgage debt cancelled or forgiven during 2018 can also be covered under the Act if a written agreement was generated during calendar year 2017.
Insolvency and Bankruptcy
Additional instances in which a tax bill may not result from receiving a 1099-C Form include those involving insolvency and bankruptcy. If a case can be made for insolvency – an individual’s liabilities exceed the total fair market value of assets – at the time that the debt was cancelled, there will be no tax liability associated with the debt cancellation.
When debt is discharged through a Chapter 7 or Chapter 13 bankruptcy proceeding, there is also no tax liability associated with the debt cancellation.
Finally, qualified farm indebtedness and real property business indebtedness can also be excluded from any tax liability that results from debt cancellation and the generation of a Form 1099-C that must be submitted when filing taxes.
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