The Tax Consequences of Forgiven Debt: The 1099-C
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Forgiven or cancelled debt seems like a good thing, but you may be trading one kind of debt for another. According to the IRS, a forgiven debt is income and, therefore, taxable. The IRS considers cancelled debt income because you received money that you are not required to pay back. Just like most other types of income, the IRS expects you to pay taxes on forgiven debt. Many taxpayers acquire tax debt because they are unable to pay taxes on forgiven debt income.
Form 1099-C, Cancellation of Debt, is a form filed by a creditor when a debt is cancelled. The creditor should send a copy of this form to both the debtor and the IRS. A 1099-C is filed only if the cancelled tax debt amount is $600 or above, and if the creditor is required to report the cancellation.
Who Reports Forgiven Debt?
Most creditors are required to report forgiven debt and will file a 1099-C with the IRS. Many times, creditors do not tell debtors about the taxes that they will need to pay on a cancelled debt.
Creditors are required to file Form 1099-C if they are:
1. A domestic bank, trust company, building and loan association, or savings and loan association. These financial institutions are described in Section 581 or 591(a) of the tax code, if you need to check further.
2. A credit union
3. Federal Deposit Insurance Corporation, Resolution Trust Corporation, National Credit Union Administration, or any other federal executive agency, including government corporations, any military department, U.S. postal service and Postal Rate Commission. Any successor or sub-unit of these also qualify.
4. A corporation that is a subsidiary of a financial institution or credit union, but only if, because of your association, you are subject to examination by a federal or state regulatory agency. If not, that entity is not required to file a 1099-C.
5. A federal government agency, such as a government department, a court or court administrative office, etc.
6. A finance company, a credit card company or any organization in the business of lending money.
If your creditor sends you a Form 1099-C, you should consult a tax professional to determine its impact on your taxes. In some cases, certain creditors file Form 1099-C even when a debt is not cancelled. This creates tax problems for the debtor, as the IRS believes that a debt has been cancelled and will assess taxes on that amount.
Forgiven Debt Not Taxed
Taxes are not assessed on certain kinds of forgiven debts. These include:
Bankruptcy –If your debt was cancelled under Chapter 7 or Chapter 13 of Title 11, then you do not need to pay taxes on the cancelled debt. If the debt was incurred due to business or investment purposes, then it may be taxed.
Interest – Forgiven interest is not taxable income.
Non-Principal amounts – These are penalties, fees, fines and administrative costs incurred in a lending transaction.
Transfer of debt to another party – If the creditor transfers the debt to another party related to the debtor.
Multiple debtors – If debt on one debtor is cancelled while the other debtors take the responsibility of paying that amount, taxes are not charged to the cancelled debt on that debtor.
Though creditors are required to issue 1099-Cs for forgiven debt, creditors do sometimes neglect to do so. The IRS requires you to report forgiven debt as income, regardless of whether you were issued a 1099-C. If you had debt that was forgiven or cancelled you should consult with a tax professional to determine if you owe taxes.