If after negotiating a debt cancellation with a lender and you receive a Form 1099-C, in most cases you’ll have to report the amount on that form to the Internal Revenue Service as income that is taxable. However, there are certain things that do apply.
In order to get by, it might be best for you to negotiate a debt cancellation with your lender in cases where your debt has gotten so large that you can no longer afford to pay it. Your next challenge, however, could potentially be a huge tax bill.
A debt you successfully cancel or negotiate away may come back to haunt you and you might consider it unfair as it becomes a taxable income once it comes back. But since you received a benefit without paying for it, the IRS classified cancelled debt as income. You no longer have to pay tax on the money you receive when you first borrow money because you are bound by a contract to pay it back. You’ll have the freedom to do whatever you want with the money once that contract no longer exists. The cancellation of your obligation to pay back the money you essentially received for free makes it taxable income.
Any debt owed by a taxpayer that is cancelled, forgiven or discharged becomes taxable according to the Internal Revenue Service. The lender that forgave the debt will send you a Form 1099-C, “Cancellation of Debt”. Some of the most common reasons why you might receive a Form 1099-C is because of repossession, foreclosure, the return of property to a lender, abandonment of property, or the modification of a loan on your principal residence.
The real estate market collapse that began in 2007 affected the citizens so much which caused the Congress to pass the Mortgage Forgiveness Debt Relief Act in 2007. You will be able to exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly and up to $1 million for other filing statuses for calendar years 2007 through 2017. For as long as there was a written agreement entered into in 2017, this also applies to debt that was discharged in 2018. Mortgage debt forgiven through a mortgage restructuring or in connection with a foreclosure is also under this exclusion.
You may still avoid taxation in the forgiveness of a debt even if you receive a Form 1099-C from a lender. You are not required to pay for taxes on the debt that was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case.
You can similarly avoid taxes on the debt that was cancelled at the time you were insolvent provided you can demonstrate it to the IRS. Qualified farm indebtedness and qualified real property business indebtedness is among other types of debt that may also allow you to avoid taxation in case of cancellation.
You need to understand that the IRS is not perfect and they can make mistakes. You may feel frustrated due to the mistake you, your creditor, or the IRS made. You are given a choice to include the amount in your income or refute to the IRS why the amount should be partially or excluded entirely when you file or receive a Form 1099-C.
Once you receive the 1099-C form you disagree with, you should contact the issuer as soon as possible. Examples of cases where mistakes are made are when people receive the form from banks they don’t have accounts with while others receive them when they didn’t want their debt cancelled. You can either ask the issue to justify why they issued the 1099-C or send them a corrected form with a zero in all appropriate sections. Its best that the process is documented as well as the copies of your documents, dates, times, and names of the people you’ve met.
It can be difficult to file for taxes when taxpayers have a discrepancy with a 1099-C. Creditors are sometimes difficult to contact or ask for any explanations from. If you are going through the same problem, you may consider reaching out to a tax professional who can help you resolve it in no time.
John Pournaras Agency