forgiven debt on your taxes
I got a letter in the mail about a "Cancellation of Debt Form
1099-C." I have settled in full on this account and have the
letter to prove it. My question is, what does that form mean? Do
I have to pay something else even though it is settled in full?
Here's a riddle for you. When is a forgiven debt
not a forgiven debt? When it's income! Form 1099-C is the form used
by lenders to report a cancellation of certain debts $600 or greater
to the Internal Revenue Service. The form reports the amount that
was forgiven in your settlement. For instance, if you had a $5,000
debt and settled with the lender for $3,500, the difference of $1,500
is considered income to you and must be figured into your annual
earnings to determine your tax liability.
I can't say whether you will owe additional taxes
at tax time, because I don't know your tax situation, and certain
types of debts are excluded -- such as debts as a result of participation
in a VA benefit or home-loan program, medical care and pharmacy
co-payments, debts which are in dispute and are written off, and
some Katrina-related debts. See a tax pro or read the IRS
instructions for details.
Just like your annual W-2 wage and tax statement,
1099 forms are sent to both the taxpayer and the IRS. If you fail
to include the 1099-C amount on your tax return, you may open the
door to an IRS audit, something most of us try to avoid.
The IRS looks upon a settlement, or a cancellation
of debt in their terms, as a "gift." Talk about gifts
with strings attached! The same thing happens to people who win
cars in store and media promotions. While it's really cool to have
a new car to drive, reality hits when they have to report $20,000
(or more) additional income with no withholding to cushion the tax
There are a number of reasons why I generally advise
against settling a debt. They include that I believe in paying what
is owed, even when it may be difficult to do so, and that settling
a debt nearly always causes a negative mark on your credit. But
as your letter demonstrates, there can be additional financial ramifications
to consider when a debt is settled for less than what is owed.
My advice to you now is to get an opinion from your
tax preparer about your specific situation and the specific debt
involved. This is not as simple as it may seem; for example, some
creditors mistakenly send 1099-C forms for charged-off rather than
discharged debts. A charge-off removes a debt from a lender's books,
but it does not forgive (discharge) a debt. The former cannot create
a taxable event; the latter may.
I would also suggest that you double-check the reported
amount on the 1099-C against your settlement letter to be sure that
the amount is correct. If the amounts don't match, you will need
to contact the creditor in writing and dispute the amount.
If you do owe additional taxes, look for budget cuts
you can make to come up with the amount due by April 17. Some areas
to consider cutting back on are eating out, dry cleaning, and telephone
or Internet premium services. If you are facing a steep bill, a
temporary second job may be in your future. Don't delay: Any tax
you owe as a result of the debt settlement is due on the mid-April
tax deadline. Even if you file for an extension, that only allows
you to file the paperwork later. The IRS starts charging interest
and penalties if you procrastinate.
Debt Adviser, Steve Bucci, is the president of Money Management International
Financial Education Foundation and the author of Credit
Repair Kit for Dummies. Visit MMI
for additional debt advice or to ask a question of the Debt Adviser go to the "Ask the Experts" page
to ask a debt question.