The IRS requires creditors to issue a 1099-C form to individuals who have had their debts forgiven or settled for less than the amount owed. It applies to debts in excess of $600.
At some point in time after a debt is settled or compromised the creditor sends a 1099-C form to both the debtor and to the IRS.
What does this mean? Essentially the amount of the debt forgiven is treated as income to the tax payer. For example a creditor ceases trying to collect a debt of $5,000. That means you have an extra (even if phantom) extra income of $5,000. The same is if a $12,000 debt is settled for $7,000: the tax payer has an extra income of $5,000. The tax payer is required to list the income on Line 21 of Form 1040 and pay income tax on it. If the tax payer does not list the income on Line 21 the IRS will send a form to the tax payer for the additional tax plus interest and penalties.
What is a cancelled Debt? Some Examples
You negotiate your credit card debt, getting the company to accept $4,000 to settle $10,000 balance. That "forgiven" $6,000 is cancelled debt, reported on Form 1099-C, and must included on Line 21 of Form 1040 as taxable income. You have a short sale on your home and the mortgage company "forgives" the remaining mortgage amount of $6000. That "forgiven" $6,000 is cancelled debt, reported on Form 1099-C and must included on Line 21 of Form 1040 as taxable income. You had a loan modification, typically on a home or rental property. The bank adjusts off some or all of a second mortgage. That adjusted amount is debt cancellation. You a car loan of $15,000 and stopped making payments. The bank repo(s) the car sells it for $5000 and forgives the $10,000 ($15,000 - $5000). The $10,000 becomes cancelled debt.
Exceptions and Defenses
Congress did exclude Mortgage Forgiveness since 2007 until December 31, 2013. Now mortgage forgiveness starting in 2014 is income. This change will be a cruel nightmare for foreclosures concluding in 2014 and thereafter. If the individual has received a discharge in bankruptcy on a case filed before the 1099-C is issued the matter is resolved. This is the least complicated option to handle the matter When negotiating a Short Sale on Real Estate there can be a provision that the debt is disputed and there is no deficiency. When negotiating a debt settlement, it is agreed the amount owed is disputed and there is no deficiency. When a 1099-C is issued the tax payer can file an IRS Form 982. In essence to the extent the taxpayer was insolvent the income is excluded. An example: the debt forgiven is $12,000 and the assets are $2,000 the income can be excluded due to the insolvency. If you think using IRS Form 982 (http://www.irs.gov/pub/irs-pdf/f982.pdf) is your best option you might consider consulting with an accountant or going to the IRS' advocate group. A useful presentation is offered at http://www.youtube.com/watch?v=qdpwtaSGpfQ.
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