It’s that time of year when creditors send out 1099-C forms for written-off debts. The IRS 1099-C is a form a creditor must issue to any debt over $600 that was forgiven or canceled during the year. Under IRS guidelines, a canceled or forgiven debt must be treated as income for the beneficiary. In other words, if a credit card company writes off $1,000 of your debt, you must claim that amount as income on your taxes. The 1099-C form let’s you know that the creditor has claimed a loss against its taxes, and informed the IRS that it has canceled or forgiven the debt.
This situation is common in debt settlement situations, and sometimes receiving a 1099-C is a great shock to the consumer, who believed wrongly that settling the debt with the creditor ended his debt nightmare once and for all. This is why speaking with a qualified consumer debt attorney (like a bankruptcy attorney) can help you understand your options and potential liabilities.
Filing bankruptcy is an exception to the canceled or forgiven debt rule. The federal bankruptcy laws and IRS laws (see IRS Publication 4681) make it clear that the debtor who receives a discharge on a debt is no longer personally liable for that debt. The debt is not considered income, and the debtor pays no taxes as a result of discharging the debt. If you receive a 1099-C for a discharged debt, don’t worry. Simply file an IRS Form 982 to claim the bankruptcy discharge exclusion for the debt.
For debt to qualify for the exclusion, the debt must have been canceled or forgiven after the date you filed bankruptcy. If the debt was canceled or forgiven prior to the bankruptcy, then you owe taxes on the debt. Taxes are not generally dischargeable, even though the debt is. For instance, say you did a short sale on your home and the lender canceled $100,000 of debt. Then you file a Chapter 7 bankruptcy three months later. Any obligation you have on the $100,000 debt to the lender is discharged, but the tax debt owed to the IRS is not discharged. Confusing? You bet! Your best option is to get professional legal advice before agreeing to a debt cancelation. The Mortgage Debt Relief Act of 2007 may provide some relief in the above situation, but it expired at the end of 2012, and offers no help for recourse loans on second homes or for other types of debt.
If you are facing a debt crisis and need professional help, arrange for a free consultation with an experienced bankruptcy attorney. A bankruptcy attorney is skilled in the nuances of consumer debt law, both federal and state, and can guide you through your financial difficulties, without making things worse with a huge tax debt!