September 16, 2020
Cancellation of Debt – Form 1099-C
Cancellation of Debt – Form 1099-C
Americans are in debt; however, the debt is on a steady increase, specifically over the last five years. The average American carries $38,000 in personal debt, this does not include home mortgages. That is up $1,000 from a year ago.
The Millennials, ages 25-34, are carrying an average of $42,000 in debt and it’s not from student loans, but from credit cards! As a whole, this age group is $1 trillion in debt, more than any other generation in history. That’s an increase of 22% in just five years.
As you can guess, there are many Americans looking to find a way to cancel their debt, be done with it, and move on. However, there are some rules to be aware of and the tax consequences of cancelling your debt.
What is a Cancellation of Debt?
A cancellation of debt is when a lender forgives, discharges, some of all the debt you owe. If the lender forgives your debt, you no longer owe this amount and the lender cannot come to collect down the road.
You are probably wondering, will a cancellation of debt hurt my credit score. No, a cancelled debt will not hurt your credit score as the damage has most likely already been done. Think about what caused the cancellation of debt. Was it due to unpaid credit card debt, a foreclosure of your home or a vehicle repossession? If the answer is yes, your late payments or failure to pay, in this case, have already been reported to the credit bureaus.
Reporting Cancellation of Debt
As stated on the IRS.gov website, a cancellation of debt income is because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.
The reason you must pay taxes on that income, unless you qualify for an exclusion or exception, is because your debt is forgiven, and you’ve already spent the money. For example, let’s use the debt from above and say you have $40,000 in credit card debt. You cannot pay the bill; the credit card company eventually gives up and forgives the debt. Well, you used the credit card and now you no longer must repay the $40,000. Therefore, you would have $40,000 in forgiven debt and that must be reported as “other income” on your 1040 tax return.
The credit card company will then mail you, and the IRS, a copy of the 1099-C, Cancellation of Debt, showing the amount of debt that was discharged, a description of the debt and fair market value of the property. It’s important to keep this form, do not throw it away as you must include this income on your return.
This form is used for many debt cancellation purposes other than credit card debt, such as; foreclosure, repossession, abandonment or a mortgage modification.
Note: A 1099-C would be issued from a creditor who forgave $600 or more in debt. If you were forgiven less than $600, you must still report the cancellation of debt on your 1040, you just will not receive the 1099-C.
What should I do with a Form 1099-C, Cancellation of Debt?
Whether you are in receipt of a 1099-C or not, it is your responsibility to keep track of the canceled debt and report it to the IRS as other income on your 1040 tax return.
In general, the creditor should be mailing you, the taxpayer, a copy of the 1099-C and a copy to the IRS. However, many times this does not happen in this order. The creditor could mail only you a copy and not the IRS. Or they may mail a copy only to the IRS, but not provide you with a copy until after taxes are due, if even at all. In any case, you must report the canceled debt even if you don’t have the 1099-C to send with a copy of your return.
If you are in receipt of the 1099-C, you should keep it in your records with all your other important tax documents. You may need this form in the event you are audited.
As mentioned above, there are some exemptions and exclusions when it comes to debt cancellation. Attempting to figure out if you qualify, or even have to pay, can be confusing. A tax professional can help you determine what is your true amount of canceled debt by reviewing an insolvency worksheet and determining what amount you must pay, or if anything at all. An expert’s advice can really help in this situation.
Are there exceptions to the Cancellation of Debt income?
Yes, there are some exceptions to the Cancellation of Debt Income.
As stated on the IRS.gov website, here are the exceptions:
- Amounts canceled as gifts, bequests, devises, or inheritances
- Certain qualified student loans canceled under the loan provisions that the loans would be canceled if you work for a certain period of time in certain professions for a broad class of employers
- Certain other education loan repayment or loan forgiveness programs to help provide health services in certain areas.
- Amounts of canceled debt that would be deductible if you, as a cash basis taxpayer, paid it
- A qualified purchase price reduction given by the seller of property to the buyer
- Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program
- Amounts from student loans discharged on the account of death or total and permanent disability of the student.
Amounts that meet the requirements for any of the following exclusions aren't included in income, even though they're cancellation of debt income.
Is there an exception for a mortgage?
When we talk about cancellation of debt on mortgages, the answer can vary greatly.
You will first need to figure your cancellation of debt income. What was the amount of debt immediately prior to the foreclosure? What was the fair market value of the property as shown on the 1099-C? If the number is more than zero, this amount is taxable unless you meet one of these exceptions.
- What was the fair market value of the home that was foreclosed?
- What was your adjusted basis, meaning your purchase price plus the cost of major improvements?
- If your amount is more than zero, you have a gain from the foreclosure. If this was your primary residence where you lived for at least two out of five years of ownership, then you may be able to exclude up to $250,000 for single filers and $500,000 for married couples, but you must file a joint return, from income. If your gain exceeds either of these amounts, then you must report this amount as taxable on the Schedule D, Capital Gains and Losses.
Are bankruptcy discharges taxable?
Typically, when you file bankruptcy, your debts are most likely not considered income. You may have filed for bankruptcy and wondering why you received a 1099-C. In the event you do, you must complete a Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness and attach it to your 1040 IRS tax return. You should also attach the 1099-C as a copy was sent to the IRS as well and it could raise some red flags if you don’t include an explanation on your tax return.
Now, you must include the amount of debt shown on the 1099-C if this form was filed before you file for bankruptcy. If that happens, it’s no longer debt, it’s now income. Remember, bankruptcy can only cancel debts, but doesn’t remove income.
What if I don’t agree with the information on the Form 1099-C, Cancellation of Debt?
If you receive a 1099-C and do not agree with the information listed, you should contact the lender as soon as possible. At that point, the lender should issue a corrected 1099-C if they agree the information is incorrect. Be sure to keep all your records as the burden of proof will always fall on you as the taxpayer!
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