1099-C surprise: 

IRS Tax Can Follow A Canceled Debt

WHEN YOU SETTLE YOUR CREDIT CARD DEBT THAT FORGIVEN PORTION OF THE DEBT MAY TURN OUT TO BE TAXABLE INCOME ? 

Have you recently negotiated with a creditor to pay less than the creditor claims you owe on a credit card debt? The IRS may consider that “forgiven” or “canceled debt” as taxable income.
Therefore it may be advisable to seek tax advice or do some research before negotiating credit card debt settlements to avoid a tax liability hit from cancellation of debt.

At the end of any year in which you’ve settled your credit card debtour clients have been increasing getting a nasty surprise – a 1099-C form, which is a "cancellation of debt" tax notice because the IRS considers forgiven or canceled debt as income. In fact, creditors who agree to accept at least $600 less than the original claimed balance are required by law to file 1099-C forms with the IRS and to send our clients notices as well. And our clients must report that portion of forgiven debt as "income" on their federal income tax returns. Your creditors will report cancelled/settled debts exceeding $600 to the IRS and you are required to report the same as income on your annual tax return. However, the IRS permits you to write off any “income” from canceled debts up to the amount by which you were “insolvent” at the time. You need to consult your own tax advisor for advice specific to your situation.     

For example, a client with $20,000 in credit card debt who negotiates to pay only $12,000 of the balance would have $8,000 in forgiven debt income. That $8,000 must be reported as "other income" on Line 21 of the 1040 tax form. Depending on the amount of debt forgiven, the client’s income level, deductions and various other factors, the client could face a sizable tax bill come mid-April.

Some clients have no clue what the 1099-C forms are and ignore the cancellation of debt notices and don’t file the 1099-Cs with their federal income tax returns and thereby risking IRS audits, penalties and fines. Many tax attorneys say  their clients are often aware of the tax implications of settling to pay a lesser amount than they actually owe.

According to the IRS, the number of 1099-C cancellation of debt forms filed with the federal government by creditors and debt collectors more than tripled between 2003 and 2010. In 2003 the IRS received fewer than 1 million 1099-C and more than 3.9 million in 2010. The projected number for 2011 is 6.3 million and the IRS estimates the volume of filings will continue to climb into 2015, when they will hit a projected 6.7 million. 
Source: Internal Revenue Service, Analysis and Statistics, Office of Research, Forecasting and Service Analysis

Negotiating with creditors, debt collectors and debt buyers to pay a fraction of the amount owed is what The Credit Card Defense Center does everyday. And we are now advising our clients about this potential for an unexpected and new tax liability.

Clients who receive the 1099-C cancellation of debt forms should immediately take them to a tax preparer or tax adviser or contact us a at info@creditcarddefensecenter.com and we’ll give you some information on how to avoid gettting hit with this tax. In fact, you may qualify for one of several exclusions that allow you to reduce taxable income from canceled debts. If the exclusions apply, you must file an IRS form 982 in addition to the 1099-C. Basically, you have income [that can be taxed] if you don't meet one of the exceptions set forth in this form.

The exclusions include debts discharged during bankruptcy and debts of clients who are insolvent (meaning their liabilities exceed their assets) prior to the cancellation of debt. However, the exclusion applies only up to the amount by which clients are insolvent. That means if $15,000 in debts were forgiven and liabilities exceeded assets by $6,000, then the $6,000 would be excluded as income. The remaining $9,000 would be reported under other income

 Consult with us at the Credit Card Defense Center  or a tax adviser before finalizing debt settlement agreements to find out the potential tax implications. Ask for a tax preparer who is knowledgeable about 1099-Cs.

 Get clarififcation with the creditor or debt collector the exact amount that will be declared on the 1099-C  form and attempt to negotiate this amount.

Be aware that the 1099-C is looming and prepare to deal with it.

Dispute about the amount reported on the form, contact the creditor or debt collector immediately to resolve the matter. Ask for a corrected 1099-C form and prepate documentation to suppirt your dispute

Note, that there is some relief for homeowners who default on mortgage loans on their primary residences becaue they may qualify for an exclusion from income on foreclosures under the Mortgage Forgiveness Debt Relief Act, which took effect Dec. 20, 2007, to help homeowners caught in the mortgage crisis. This provision applies to up to $2 million in mortgage debt forgiven in calendar years 2007 through 2012. But note that taxes filed by the April 2013 deadline will be the last opportunity to claim the mortgage debt forgiveness exemption -- unless Congress passes an extension.

Also note, however, that If you use the proceeds from a home equity line of credit to pay off credit card debts, or for something other than making improvements to your home, that portion will not qualify for the $2 million exception.

If you used a credit card to pay for home improvements on your primary residence and can prove that the charges were exclusively for home improvements, you may be able to claim an exemption from mortgage-related debt forgiveness income for that card debt.

If you need more help in understanding the tax consequences of canceled debt in listen to the IRS produced audio program at the IRS website and see the videos produced The Taxpayer Advocate's Office at YouTube in an effort to demystify the 982 tax formsyou will need to claim an exemption from taxes on forgiven debt.

 



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Debt Settlement with 1099-C for Discharged Debt or Canceled Debt: IRS Form 1099-C Cancellation of a Debt

New! New York Residents: Settle Your Debts

Debt settlement is a debt relief option that has become increasingly popular among people who need relief from high-balance credit cards (typically $20,000 - $125,000). Through debt settlement, debt specialists negotiate with creditors on your behalf - with the goal of "settling" for substantially less.

1. How much credit card debt do you currently have?

$20,000

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1099-C for Debt Settlement

Last Updated: May 21, 2012

If and when you settle a debt for less than what you owe, it feels like a done-deal to be celebrated. But temper that sigh of relief with the knowledge that, though you may no longer be required to pay back said debt, the IRS expects you to claim that amount as income. How can they possibly know what of your debts have been forgiven? Via a 1099-C form, which creditors are required to file under certain circumstances surrounding cancellation of debt.

What is a 1099-C Form?

A 1099-C is a cancellation of debt form filed with the IRS by a creditor that has either 1) reached a settlement with a debtor for less than was originally owed, or has 2) forgiven the entire debt, concluding it will never be able to collect the debt.

What Sort of Debt Qualifies for Inclusion on a 1099-C Form?

Debt that may be claimed on a 1099-C form includes stated principal, stated interest, fees, penalties, administrative costs, and fines.

What is the Significance of a 1099-C Form to the Debtor?

If and when a creditor issues a 1099-C in your name to the IRS, whatever amount is included on the form is considered income that you must claim and pay taxes on.

When is a Lender Required to File a 1099-C?

Creditors must file a 1099-C with both the IRS and with the debtor for all debts of $600 or more under the following circumstances:

1.             Cancellation or extinguishment making the debt unenforceable in a receivership, foreclosure, or similar federal or state court proceeding.


2.             Cancellation or extinguishment when the statute of limitations for collecting the debt expires, or when the statutory period for filing a claim or beginning a deficiency judgment proceeding expires. Expiration of the statute of limitations is an identifiable event only when a debtor's affirmative statute of limitations defense is upheld in a final judgment or decision of a court and the appeal period has expired.


3.             Cancellation or extinguishment when the creditor elects foreclosure remedies that by law end or bar the creditor's right to collect the debt.


4.             Discharge of indebtedness by agreement between the creditor and the debtor to cancel the debt at less than full consideration.


5.             Discharge of indebtedness because of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. A creditor's defined policy can be in writing or an established business practice of the creditor. A creditor's practice to stop collection activity and abandon a debt when a particular nonpayment period expires is a defined policy.


6.             The expiration of nonpayment testing period. This event occurs when the creditor has not received a payment on the debt for a 36 month period beginning on December 31st. (this 36 month period is rebuttable by creditor based on facts and circumstances)

What Information is Included on a 1099-C Form?

1.             Date debt was canceled.

2.             Amount of canceled debt.

3.             Amount of canceled debt attributable to principal only, reduced by any amount received by lender in satisfaction of debt.

4.             Description of origin of debt (i.e., student loan, mortgage, or credit cards).

 

Am I Required to Report as Income an Amount Filed Via a 1099-C by a Collection Agency, or Only if it is Filed by the Original Creditor?

 

It depends on whether or not the collection agency can prove you owe the debt, which they may not be able to do since your account may have been transferred so many times that the proof of your debt has been left behind in the process.

 

Debt validation is key. If the collection agency cannot prove that you owe the debt, but they have filed a 1099-C, you may include with your tax return a letter stating that said agency has no proof that you owe the debt.