You have a debt if you borrow money and are legally required to repay a definite or determinable sum at a later period. You could be personally liable for a debt or possess property that is encumbered by one.
Your debt is considered canceled in the amount that you don’t have to pay if it is forgiven or discharged for less than the entire amount you owe. However, there are a few exceptions to the rule, in which the amount you don’t have to pay isn’t considered canceled debt. These exceptions will be covered in greater detail later. A debt may be cancelled if the creditor is unable to collect, or has given up trying to collect, the amount you owe. A foreclosure, repossession, voluntary transfer of the property to the lender, abandonment of the property, or a mortgage modification may result in the debt being cancelled if you own property subject to a debt.
In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you owe, the canceled debt is taxable, and you must record it on your tax return for the year it occurred. If the law specifically enables you to deduct it from gross income, the canceled debt isn’t taxed. These exclusions will be explained in more detail later.
After a debt is canceled, the creditor may give you a Form 1099-C, Cancellation of Debt, which includes information such as the amount of the debt cancellation and the date of cancellation. If the information on your Form 1099-C is erroneous, contact the creditor to get it corrected. For example, if the creditor is still attempting to collect the debt after mailing you a Form 1099-C, the debt may not have been canceled, and you may not have income from a canceled debt. You should confirm your individual situation with the creditor. Whether or not you receive a valid Form 1099-C, it is still your duty to declare the taxable amount of canceled debt as income on your tax return for the year in which the cancellation occurs.
If the debt is a nonbusiness debt, you must report any taxable amount as ordinary income from the cancellation of the debt on Form 1040, U.S. Individual Income Tax Return, Form 1040-SR, U.S. Tax Return for Seniors, or Form 1040-NR, U.S. Nonresident Alien Income Tax Return as “other income” on Form 1040, U.S. Individual Income Tax Return, or Form 1040-NR, U.S. Nonresident Alien Income Tax Return, or Canceled Debts, Foreclosures, Repossessions, and Abandonments, Publication 4681 (for Individuals).
Caution: If you have property that secured your obligation and the creditor takes it in full or partial payment of your debt, you are considered to have sold it to the creditor. If you were personally liable for the debt (recourse debt) or not personally liable for the debt (non-recourse debt), your tax treatment will differ (nonrecourse debt).
The amount realized if your property was subject to a recourse debt is the property’s fair market value (FMV). The amount of the debt in excess of the FMV of the property that the lender forgives is your usual income from the debt cancellation. Unless you meet one of the exceptions or exclusions listed below, you must include the debt cancellation in your income. Gain or loss on the sale of the property will be the difference between the FMV and your adjusted basis (typically your cost).
If your property was subject to a nonrecourse loan, the total amount realized is the nonrecourse debt plus any cash and the FMV of any property you received. You will not receive regular income as a result of debt discharge.
The examples below demonstrate the distinction between recourse and nonrecourse debt.
- You paid $2,000 down and signed a $18,000 recourse note on a $20,000 boat for business use. You are no longer able to make payments on the note after paying down $4,000 on it. The boat was repossessed by the boat dealer, and it is now worth $11,000. You will receive $3,000 in regular income from the debt cancellation ($14,000 outstanding debt owed less $11,000 FMV of boat). The difference between the boat’s FMV of $11,000 (the amount you realized on repossession) and $20,000 will result in a $9,000 loss on disposition (your adjusted basis in the boat).
- The only difference is that when you bought the yacht, you signed a nonrecourse note. When the dealer repossesses the boat, you will lose $6,000, which is the difference between the $14,000 realized (the face amount of the remaining debt) and the $20,000 you paid for it (your adjusted basis in the boat). You have no regular income as a result of the debt elimination.
For further information on canceled debt and reporting gain or loss from repossession, foreclosure, or abandonment of property, see Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). Publication 544, Asset Sales and Other Dispositions, and Publication 523, Selling Your Home, are also helpful.
Amounts that meet the criteria for any of the following exceptions are not considered debt cancellation income.
How does a 1099-C affect my tax refund?
Any tax paperwork you get should never be ignored because it could have a favorable or negative impact on your tax return. However, if you receive a 1099-C form reflecting a substantial amount of revenue, you need not be alarmed. It doesn’t always mean you’ll owe a lot more money in taxes.
To begin, determine if the sort of debt cancellation reported on the 1099-C form is taxable income. Excluded debts include those forgiven because you were insolvent or involved in certain types of bankruptcies, according to the IRS. You should check with your bankruptcy attorney to see if you need to file a 1099-C for income related to your bankruptcy discharge.
You must include the 1099-C in your federal tax return once you’ve determined whether or not you need to report the income. If the canceled debt does not qualify for an exclusion, you must declare it on your tax return as “other income.”
This revenue will be added to your other earnings to determine the amount of tax you must pay for the year. In other words, you’ll have to pay taxes on the additional earnings. This could result in a smaller refund or you owing more taxes than you would otherwise.
You may still need to file a form if the 1099-C canceled debt falls under an IRS exclusion, which means you won’t have to pay taxes on all or part of the income. A copy of the 1099-C was sent to the IRS by the creditor who provided it to you. It could raise a red flag if you don’t mention the form and income on your own tax return. An audit or needing to prove to the IRS later that you didn’t owe taxes on that money could arise from red flags.
Fortunately, the IRS has a form that can be used for this purpose. It’s Form 982, Reduction of Tax Attributes Due to Indebtedness Discharge.
How much is Cancelled debt taxed?
You may be taxed on any forgiven debt over $600 if you are able to reach a settlement that is much less than your total obligations outstanding.
“The creditor must file a 1099-C form with the IRS detailing the amount of your resolved debt,” Tayne explains. You will also receive a copy of the 1099-C forgiveness of debt form from the forgiving creditor in the tax year in which the last payment is made, similar to income tax forms.
“That paperwork will tell you the amount forgiven,” Tayne explains, referring to the amount that isn’t taxable income. On your tax forms, there is a designated line for this reason.
This rule has some exceptions and exclusions, which are listed below. Tayne contends that even if you do end up paying taxes on your forgiven debt, “you’ll generally be better off than if you had to pay the full sum.”
How do I avoid paying taxes on a 1099-C?
Form 1099 is a statement of information. It is sent out on a regular basis and without much thinking on the part of the creditor.
When real estate is transferred or a debt is forgiven, the creditor is obligated to notify the transaction to the Internal Revenue Service.
You, as a potentially impacted taxpayer, will receive a copy.
Claim the exceptions to the rule
The Internal Revenue Code begins with the premise that forgiven debts improve your net worth. There must be a tax payable, according to IRS logic.
If you qualify for one of these exclusions, the forgiven debt will not be added to your taxable income.
You must complete IRS Form 982 to substantiate your entitlement to exclude the money stated on the 1099.
If you don’t file the form and claim the exception, the IRS will have no means of knowing that there is no tax due despite the debt forgiveness.
Form 982 tax-avoiding choices
Bankruptcy–In bankruptcy, the debt is forgiven without any tax penalties. On Form 982, it’s the first exception. Title 11 of the United States Code contains bankruptcy laws. The tax exemption applies to debt discharges in any bankruptcy chapter.
Insolvency–Perhaps you owed more to other creditors than the worth of your assets when the debt in question was forgiven.
The forgiven debt isn’t required to be included in your income.
You were bankrupt.
However, keep in mind that the value of retirement assets that your creditors can’t get is factored into the solvency assessment.
When you factor in pensions, etc., many people who have little net worth outside of retirement funds are actually solvent.
With the Great Recession and a rash of foreclosures, Congress provided a temporary safe harbor for debt forgiven on a primary property.
The loan has to be utilized to purchase or upgrade the home.
The law was recently extended to cover the 2016 tax year.
In case of mistake
Another instance in which you can receive a 1099 but not owing tax is if you had no personal culpability for the debt forgiven; that is, the debt was a non recourse debt. The foreclosure agent is unlikely to know whether the lender had the legal authority to suit you.
If none of the other exceptions to including income apply, think about whether you were personally liable for the debt.
If not, request a correction to the 1099 or provide an explanation with your tax return detailing the facts of your situation.
Do I have to report a 1099-C on my taxes?
Negotiating a debt cancellation with your lender may be just what you need to get by if your debt has become so huge that you can no longer afford to pay it. Unfortunately, a hefty tax bill could be your next hurdle. In most cases, if you get a Form 1099-C from a lender, you must declare the amount on the form as taxable income to the Internal Revenue Service. There are some exceptions.
What happens if you don’t file a 1099-C?
According to Bruce McClary, a spokesman for the National Foundation for Credit Counseling, failure to record the forgiven debt on your income tax return could result in a bill from the IRS or potentially an audit if you didn’t receive a 1099-C in the mail.
To begin, contact the financial institution that handled the debt settlement. If it doesn’t work, you can ask the IRS for a pay and income transcript for the relevant tax year. You can get it by filling out an online form or phoning 800-908-9946.
Does a 1099-C hurt you?
The IRS requires lenders to use a 1099-C tax form to record “cancellation of indebtedness revenue.” This form must be filled out if a debt of more than $600 is cancelled or goes unpaid for an extended period of time. The lender must file this form with the IRS and send a copy to the taxpayer as well. However, because a copy of the 1099-C is not sent to credit reporting agencies, the fact that you got it has no bearing on your credit reports or scores.
How can I avoid paying taxes on a Cancelled debt?
To make matters worse, you’ve also received a 1099-C Cancellation of Debt paperwork in the mail, which shows the forgiven sum. Suddenly, you’re in the middle of a tax nightmare.
Unless you qualify for an exclusion or exception, the IRS states that if a debt is canceled, forgiven, or discharged, you must include the canceled amount in your gross income and pay taxes on that “income.” The IRS requires creditors who forgive $600 or more to file Form 1099-C. The IRS handled about 2.7 million of these forms in 2009, and that number is projected to rise for the 2010 tax year.
The tough element is determining whether you are eligible for an exclusion or an exemption. You may end up paying more in taxes than you need to if you don’t get it right (or neglect it entirely). However, determining how much you must pay may be more difficult than it appears.
Does the IRS have a tax forgiveness program?
The IRS debt forgiveness program is essentially a program designed to make it easier for taxpayers who owe money to the IRS to repay their debts by providing tools and help. If the individual can prove great financial hardship and has filed all past tax returns, the IRS will forgive the amount.
How much tax do you pay on a 1099-C?
The 15.3 percent self-employment tax is the most common reason why people are caught off guard when filing a 1099-MISC. The tax rate on Form 1099 is split into two parts: 12.4 percent for social security and 2.9 percent for Medicare. Regardless of your salary classification, everyone is subject to the self-employment tax. The majority of this is handled by your employer for W-2 employees, but not for self-employed people!
After utilizing our free 1099 tax calculator, you won’t be as concerned about your tax liability. We’ll teach you how to use deductible costs to lower your tax bill in the next section.
Is Cancellation of debt self employment income?
In his personal Form 1040 tax return, a solo proprietor reports company income and costs. The information is submitted on Schedule C for most self-employed business owners, however some businesses require reporting on Schedule E or Schedule F. In most cases, if a business owner is personally liable for a debt, debt forgiveness must be reported as income and is taxable. Debt forgiveness, on the other hand, is not taxed in certain circumstances and on certain schedules.
