Most people struggle at one time or another to their pay bills. Often, the payments fall further and further behind, and climbing out from the debt cycle feels hopeless.
If you’re in this situation, you may have asked the bank, credit card company, or another creditor to write off or forgive your debt — usually for much less than is due on your account. In some cases, the lender will agree and stop trying to collect due to time, circumstances, or other contributing factors.
What you may not know is that when the lender writes off your debt, they may assign you a form 1099-C (cancellation of debt). This 1099 gets sent to the appropriate taxing agencies, and it will appear in your IRS file for the year the debt was charged off or forgiven. But what does a 1099-C really mean? Do you have to do anything after a creditor writes off your debt? What is your responsibility? In this article, we’ll answer those questions and explain the basics of how debt forgiveness affects taxes.
If a lender charges off debt on their books and issues you a 1099-C, the amount disclosed on the form counts as additional taxable income for the tax year in question. You must account for this extra income on the corresponding year’s personal tax return.
It might seem unfair to have a crushing debt forgiven, only to have the forgiveness come back to haunt you and raise your tax bill. Unfortunately, that’s how U.S. Tax Code works. The IRS classifies canceled debt as income because you received a benefit without paying for it.
There are a few circumstances where you may be able to get an exclusion on the canceled debt, which will allow you to avoid adding it to your gross income for the year:
If you qualify for an exclusion, you must fill out and file IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness and Section 1082 Basis Adjustment.
Whatever you do, don’t ignore the issue and try to hide the debt forgiveness from the IRS — this will only create more problems later. Even if you don’t get a 1099-C from the creditor who forgave the debt, you should report the income when you prepare your taxes.
The bottom line is that if you borrowed money and then had the debt written off or negotiated the amount down, the amount forgiven is often subject to income tax. Debt forgiveness can complicate a tax return, so you should consult a reputable tax preparer for the year in question.
At S.H. Block Tax Services, we offer tax counseling and tax preparation, along with many other tax-related services. If you had a cancellation of debt in the current year or a previous year, we encourage you to reach out and get advice from our talented tax team.
RELATED: Made a Mistake on Your Taxes? Fix It With an Amended Tax Return
If you have any questions or concerns about an outstanding tax debt or any other tax matters, please contact the experienced tax team at S.H. Block Tax Services. Our skilled attorneys and tax experts have experience working with the IRS to resolve issues and protect taxpayers’ rights.
Schedule your free consultation today by calling (410) 872-8376 or completing the brief contact form on this page.
The content provided here is for informational purposes only and should not be construed as legal advice on any subject. Please read our full disclaimer here.
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