April 15th is right around the corner and that means, it’s time to pay up.
For many Americans 2011 was another year of unemployment, rising costs, and underwater mortgages. In fact according to the Federal Reserve Bank of New York Americans owe a combined $11.5 trillion on credit cards, car loans, mortgages and other consumer debt.
So in a desperate attempt to keep their finances afloat many have turned to settling their debts. Settling a debt is certainly damaging to your credit, but to make matters worse, Uncle Sam wants his take as well.
If you have a debt forgiven it is important to know that the amount of forgiven debt is taxable and could mean an unexpected tax bill.
How is debt forgiven?
There are a few ways you can have an unsecured debt forgiven.
- You are the negotiator. A large credit card bill can slaughter your monthly budget and cause you to fall behind on payments, face interest rate hikes and eventually put you in a position where making monthly payments just aren’t possible anymore. You can contact your creditor and offer to settle for less than what you owed. The caveat most will only accept the settlement as a lump sum, so be prepared to pay on the spot or within 30 days. Be sure to have the agreement defined in writing and disclosed as “settled—paid in full”.
- Hire a debt settlement provider. A debt settlement provider essentially does the same thing, however they handle all the headaches of dealing with the creditors. The provider sends formal letters to the creditors notifying them of the intent to settle, negotiates on your behalf and are often able to have more of the debt forgiven due to the large volume of debts they settle. There is usually a fee involved and recent legislations have made sure that those fees are not collected upfront.
So let’s just say you were successful in having some of your debt forgiven, that’s great news and certainly will help your bottom line! But wait, there’s a catch…
Debt Forgiveness is income
While you may not consider the negotiated balances of your credit cards as income, Uncle Sam sure does. If you have debts that have been forgiven such as negotiated balances on credit card bills expect to receive a 1099C when tax time rolls around. What is a 10099C?
The IRS will send this form if a Federal Government agency or lender has forgiven a debt that you owed. If a creditor has forgiven a debt you are required to include the forgiven amount as income for the year.
Of course, there are some exceptions:
- Bankruptcy debt. This type of debt forgiveness is not taxable.
- Mortgage debt. If you have been through a short sale chances are a large amount of your mortgage was forgiven by your lender. The Mortgage Debt Relief Act of 2007 was created due to the decline in property values and eliminates the need to pay taxes on this type of forgiven debt.
- Non-recourse loans. A non-recourse loan such as a mortgage or car loan that is subject to foreclosure or repossession doesn’t require a 1099C however there may be other tax ramifications.
So if you fell on hard times and had debt forgiven this year expect to be hearing from Uncle Sam in the form of a 1099C. If you were able to settle with a creditor under an agreement that they would not report the forgiven debt to the IRS be sure to get it and any other agreements in writing to avoid any miscommunications come April 15th.
Have you ever settled a debt either on your own or with a debt relief provider and received a 10099C?
**I am not a tax professional, for specific information as it relates to your situation please consult a tax professional. **
Nearly every tax season, I speak with people who are surprised about receiving a 1099C.
I have a slight correction. 🙂 1099s are not prepared and sent to you from the IRS; they are prepared by the payer. In the case of 1099C, they are prepared by the entity which cancelled the debt. I think this is important to know, because mistakes can happen. If you receive any 1099, you should always compare the information to your own records and verify the accuracy.
For example, recently a client brought in a 1099C for 2011 issued from a credit card company. The client had defaulted on the debt, but it had been several years. As it turned out, the same cancelled debt had been reported on a 1099C in 2009, and the client had already paid the tax due. For some reason, the company had issued a second 1099C in error! The issuer was a large national bank. I’m willing to bet that if they were double reporting my client’s 2009 cancelled debt, they were double reporting other people’s 2009 cancelled debt too.
If you should receive an erroneous 1099, you should follow up with the entity who issued it to you. They will need to file a corrected 1099 copy A and 1096 with the IRS, or else it will come back to haunt you. Eventually, the IRS gets around to matching up the information reported to them with your SS#. If it doesn’t match up (with what you have reported on your income tax return) you will be hearing from them.
Thanks for the reminder that debt forgiveness counts as income from the IRS’s point of view. It’s important to mark any debt forgiveness down on paper (or a Word document for those of you who are tech-savvy) and give it to your tax preparer at year’s end.
@Petunia 100 Thanks for the correction and all of the added information. It’s tough for those facing this unexpected expense to understand and deal with.
@John I love the idea of keeping track of any debt forgiveness throughout the year either digitally or the old fashioned way–thanks for sharing 🙂
Yes, I did use debt settlement a while back, but the cost of paying the IRS was much less than the interest I would have lost paying the banks (who were unwilling to offer much help when it was needed the most).
@Kris Funny how that works…when you are need of help they are unwilling to provide it, when you are not they flood you with offers 🙁 In most cases I believe your situation is the norm; the amount owed to the IRS is much less than all the accumulated interest.
Hi my name is John. We were told a form 982 will excuse you from paying taxes on your unpaid debt. Is this true or just a way for them to get us into a debt settlement program instead of a debt management program which, we’re told, won’t have this problem? Please advise
You should most certainly discuss this with your tax preparer or contact the IRS for further clarification of your tax rights. Based on the following information it appears in some instances a person may be able to take advantage of Section 108 of the tax code, and complete a Form 982. Essentially it states if someone is truly insolvent the forgiven debt may not be counted as taxable income.
Here are the links:
· http://codes.lp.findlaw.com/uscode/26/A/1/B/III/108
· http://www.irs.gov/pub/irs-pdf/f982.pdf
Again, please be sure to review this with a tax representative or someone from the IRS.