Bankruptcy and Form 1099

The recession of 2008 created massive debt problems for many people. With layoffs, plummeting stocks, and business closings, people could no longer pay their unsecured debts and even some of their secured debts. Unsecured debts are considered credit cards, medical bills, personal loans, and any other debt not secured by some type of collateral. Secured debts are secured by a form of collateral, usually a car or a home or investment property. When a person can no longer pay these debts, the creditors will first try to collect on the debt by contacting the person via mail and/or phone. Creditors are relentless and will continue to harass you through this collection process. At some point, the creditor decides it is no longer worth it to try to get the debt paid back by you. This article explains the consequences of not paying the debt back and what happens next with Form 1099.

What is a 1099 Form from the Internal Revenue Service, ("IRS")? A 1099 Form will usually be either a 1099C Form, "Cancellation of Indebtedness Income" or a 1099A Form, "Acquisition or Abandonment of Secured Property". While you will not receive a 1099A for unsecured debt, you could receive either a 1099A or 1099C on secured debt. These forms refer to forgiven or canceled debt that the IRS views as "taxable income". Here are some situations that will trigger receipt of the 1099 Form:

� Foreclosure of your home or investment property

� A short sale of your home or investment property

� Settlement of debt with a creditor of at least less than $600 of the original balance

� No activity on a debt for at least 3 years including no collection activity

In any of the above scenarios, the creditor is required by law to send you a 1099C or 1099A Form. The creditor also sends the Form to the IRS. This creates a tax liability on the forgiven debt being treated as "taxable income." For example, you owe $10,000.00 on a credit card. You agree to settle the debt with the credit card company for $4000.00. The credit card company will then send you a 1099C Form for $6000.00. The IRS will then require you to pay taxes on that $6000.00 forgiven debt. Many people do not know of this requirement and will throw the 1099 Form away without even thinking about it. It is very important that you take it seriously when you receive a 1099 Form and contact a tax preparer or advisor to see about your options. Failure to pay taxes on a 1099 debt can result in IRS audits, penalties, and/or even fines.

So what can you do to protect yourself from the dreaded 1099 tax liability? Well, there are some exclusions to paying taxes on forgiven debt. There is a form, Form 982, that you can fill out and if you meet the requirements, you can avoid paying taxes on the forgiven debt. Form 982 lists some options, two of which are usually the most important for anyone considering bankruptcy:

� Filing bankruptcy under Title 11 of the United States Bankruptcy Code and

� Insolvency at the time of cancellation of the debt

Filing bankruptcy on debts in a Chapter 7 discharges all unsecured debts once your Order of Discharge is entered. This means that any unsecured debts, which include debts for deficiencies on items sold or foreclosed on like a house or a car, are erased and you are no longer responsible for them. If you file bankruptcy and included the debt on the Form 1099, then that debt is discharged and you will not have a tax liability for it. If you file a Chapter 13 bankruptcy agreeing to pay back a portion of your debts over 3-5 years and your Chapter 13 Plan is confirmed by the Court, then you will not have tax liability on any 1099 Forms sent to you. Bankruptcy, thus, is a very helpful resource to prevent debts from unsecured sources or from deficiencies from repossessions or foreclosures from becoming a tax liability.

However, there is a timing issue to be aware of. If the Creditor creates a 1099 Form prior to your filing bankruptcy, then the debt can be considered non-dischargeable in either Chapter 7 or Chapter 13. For example, your house is foreclosed on and the lender sells the house. The house sells for less than you owe by $30,000.00. The lender then issues a 1099C or 1099A Form to you in the amount of $30,000.00 of forgiven or canceled debt. Once this Form is issued and sent to the IRS, this "income" becomes a tax liability. In bankruptcy, tax debts are, for the most part, considered a priority debt and therefore, non-dischargeable. The best thing to do is to meet with a bankruptcy attorney early enough in the process so that you can get your case filed before the forgiven or canceled debt becomes a priority tax liability.

The other most used option to avoid paying taxes on a 1099C or 1099A Form is to choose that you were insolvent at the time the debt was canceled on Form 982. The IRS defines this option as, to "prove you were insolvent immediately before the cancellation of the debt to the extent that the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation." Assets include everything you own, which means your exempt assets, such as retirement accounts, are also included. You can learn more about this option by reading IRS Publication 4681. In conclusion, do not ignore Form 1099C or 1099A should you receive it. Meet with a tax advisor, financial advisor, and/or a bankruptcy attorney as soon as possible to protect yourself and learn your options.