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Justin Harelik, the Bankrate.com Bankruptcy AdviserReporting forgiven debt as taxable income

Dear Bankruptcy Adviser,
I filed bankruptcy in October 2006. We had a business that we had to close and had racked up a lot of credit card debt trying to keep it going. I just found out that I might have to get 1099s from the credit card companies and claim the money as income on my taxes this year. Is this true?
-- Bobbi

Dear Bobbi,
Form 1099 is sent by companies to report miscellaneous income. They will send one to you and one to the IRS. Without knowing more about your specific situation, I cannot say 100 percent whether you will receive 1099s from the credit card companies. However, the vast majority of bankruptcy filers will not receive the 1099 tax forms from their credit card companies.

You will not need to claim any money you've received from them as income. Because you filed bankruptcy, your debt has been discharged.

However, you've asked a great question and I think a lot of people would be interested in knowing when you may have to receive 1099s. The issue is when debt is forgiven, not discharged.

What is the difference?

Suppose you've got $20,000 in credit card debt, and for whatever reason, you can't make the monthly payments. You file bankruptcy and the debt is discharged. Effectively, you've received $20,000 from the credit card companies and that's income. However, you're not paying taxes on this money because the bankruptcy laws protect you. It's the government's way of saying, "Hey, you appear to be under enough stress already. We're not going to make it worse." Nice guy, that Uncle Sam.

Now, if you received that same $20,000 and you don't want to file bankruptcy, but you do have some money with which to negotiate a settlement, you -- or a negotiator you retain -- might call the credit card company and offer them a deal like this: "I can't pay back the $20,000. If I file bankruptcy you may get nothing. But I can give you $15,000 if you'll forgive the remaining $5,000."

If the credit card company agrees, that $5,000 has been forgiven and does count as income. They may, repeat may, send you a 1099, and in that case you'll have to pay taxes on it, unless you qualify for the insolvency exception.

For more information on the ins and outs of insolvency, whether your debt is includable, and even phantom capital gains, I recommend talking to either a CPA or an attorney in your state.

Best of luck to you in your new financial life.

Justin Harelik is a practicing attorney in Los Angeles. To ask a question of the Bankruptcy Adviser, go to the "Ask the Experts" page and select "bankruptcy" as the topic.

Bankrate.com's corrections policy-- Posted: Feb. 13, 2007
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