debt

When must debt collectors give up?

Steve BucciDear Debt Adviser,
I have a debt that's expected to be charged off and forgiven by my creditor. But what happens to third-party debt collectors? Can they still pursue me if the debt's inside the statute of limitations? And what kind of taxes must I pay for that forgiven debt?
-- Sarah

Dear Sarah,
This a great question that illustrates what can happen to an old debt. It raises four key issues that need some attention: charge-offs, statutes of limitations, debt forgiveness and credit reporting. Let's touch on each briefly.

  • Charge-offs: When a debt is charged off by a creditor, it means the creditor doesn't expect that money to come back. Your debt hasn't been forgiven yet, however. It's still owed and considered collectible.
  • Statutes of limitations: The debt also doesn't disappear after the statute of limitations in your state. The only difference is that creditors can't take you to court. Creditors can ask for the money over the phone or in writing, but they can't sue for it.
  • Debt forgiveness: When a debt is forgiven (this is sometimes part of a settlement process), the creditor will send a 1099-C cancellation of debt tax form to the debtor and the Internal Revenue Service. The IRS requires that when a debt of more than $600 is forgiven, the amount forgiven should be considered income to the debtor.
  • Credit reporting: None of the above makes a difference on your credit report. Whether your debt is charged off, forgiven, or beyond the statute of limitations, it still gets reported and affects your credit and score for seven years. Your creditors may forgive, but the bureaus don't forget.

So, if a 1099-C shows up in your mailbox, your creditor has forgiven the debt, and you shouldn't have to worry about debt collectors. But make sure you report the forgiven debt to the IRS. The IRS is good at tracking income tax returns that should include canceled debt as income. If you are flagged as receiving a 1099-C but do not include it on your tax return, you could face a tax bill plus penalties and interest.

There are some exceptions. If the debt was forgiven in bankruptcy, or if you were insolvent (owe more than you own in assets) at the time the debt was forgiven, you could qualify for an exemption. You would need to file IRS Form 982 with your tax return if one of the exemptions applies to you.

If you plan to file Form 982, you should seriously consider running it by a tax professional. The code is rarely clear, and I want you to be sure that you actually qualify for the exemption. You don't want to owe the IRS, ever. They are much less forgiving than regular creditors.

Because of the confusion old debts cause, let me reiterate that just because a debt is charged off by your creditor does not mean that the debt is forgiven. Most creditors pursue old debts until they exhaust all their legal options. As long as the statute of limitations has not expired, it is likely you will be contacted by debt collectors. You will need to come up with a plan to pay what you owe, or you could wind up in court.

Finally, keep copies of your 1099-C and your tax return just in case you need to show proof of your forgiven debt to an errant debt collector.

Good luck!

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