It's unwise to ever ignore a canceled debt, or receipt of a 1099-C, especially since the IRS expects to have that specific income included within your return – unless there is an exclusion or exception. You should also track canceled debt, even if you didn't receive a 1099-C.
If you don't report the taxable amount of the canceled debt, the IRS may send you a notice proposing to assess additional tax and may audit your tax return. In addition, the IRS may assess additional tax, penalties and interest.
The issuance of the 1099C does not even mean that the creditor cannot still collect the debt. There are ways to avoid having to pay tax upon the amount of debt written off or forgiven, though.
Although there is a statute of limitations on old debt, there's no statute of limitations on 1099-C forms—which means that lenders and debt collectors occasionally send out 1099-C forms on very old debts. If you receive a 1099-C on an old debt, your best option is to contact a CPA or tax professional.
Your forgiven debt must be less than your liabilities to exclude it as taxable income. In this case, a forgiven debt of $5,000 but not $10,000 could be excluded, because it is less than the amount of your insolvency.
Cancelled debt
Unfortunately, your next challenge might be a huge tax bill. In most situations, if you receive a Form 1099-C from a lender, you'll have to report the amount of cancelled debt on your tax return as taxable income. Certain exceptions do apply.
If you receive a 1099-C, you may have to report the amount shown as taxable income on your income tax return. Because it's considered income, the canceled debt has tax consequences and may lower any tax refund you are due.
The penalty amount depends on how late the form is filed and the size of the organization: $60 per form if filed within 30 days of the due date, with a maximum penalty of $220,500 per year. $120 per form if filed more than 30 days after the due date but by August 1st, with a maximum penalty of $630,500 per year.
Contact the creditor if you receive a 1099-C reflecting incorrect information. If a creditor continues to attempt to collect the debt after you receive a 1099-C, the debt may not have been canceled and you may not have income from a canceled debt. Verify your specific situation with the creditor.
The 36-month non-payment rule, as set forth in Reg. Section 1.6050P-1(b)(2)(iv), established a rebuttable presumption that an identifiable event has occurred, resulting in a requirement to file a Form 1099-C, if a creditor does not receive payment on a loan within a 36-month testing period.
Regardless of whether or not the 1099-C will increase your taxable income, you should be aware that the IRS receives a copy of this form as well, so you should fill out an amended tax return to reflect the changes.
Lenders or creditors are required to issue Form 1099-C, Cancellation of Debt, if they cancel a debt owed to them of $600 or more. Generally, an individual taxpayer must include all canceled amounts (even if less than $600) on the "Other Income" line of Form 1040.
Form 1099-C must be filed regardless of whether the debtor is required to report the debt as income. The debtor may be an individual, corporation, partnership, trust, estate, association, or company.
You will not have to pay this back, but you may have to claim it as taxable income to the Internal Revenue Service (IRS).
File Form 1099-C for each debtor for whom you canceled $600 or more of a debt owed to you if: You are an applicable financial entity. An identifiable event has occurred.
Generally, if you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.
The 1099-C form reports a cancellation of debt; creditors are required to issue Form 1099-C if they cancel a debt of $600 or more. Form 1099-C must be issued when an identifiable event in connection with a cancellation of debt occurs.
The IRS notes that creditors do not need to issue a 1099-C cancellation of debt in some cases: Debts being canceled as a gift or through inheritance. Some student loans that are canceled. Certain credits provided by property buyers.
Most canceled debt is taxable
If you are able to get a settlement that's significantly less than your total debts owed, you will be taxed on any forgiven debt over $600. “The creditor is required to file a 1099-C form with the IRS, which will detail the amount of your settled debt,” says Tayne.
Cancellation of debt income isn't subject to taxation if it's excluded from your gross income. Any debt that's discharged in a Title 11 bankruptcy isn't included in your gross income. That exclusion applies to debt canceled during insolvency, too.
If you forget to report the income documented on a 1099 form, the IRS will catch this error. When the IRS thinks that you owe additional tax on your unreported 1099 income, it'll usually notify you and retroactively charge you penalties and interest beginning on the first day they think that you owed additional tax.
Debt settlement programs and bankruptcy both have the potential to result in forgiven debt, but they're also likely to have a significant impact on your credit score and your ability to borrow.
But if you change your mind, you can cancel a DMP at any time. Some of the potential reasons you may consider canceling your DMP include: Your financial situation has improved and you no longer need the DMP. You've received a windfall of cash and can pay off your debt in full.
Although loan forgiveness can impact a credit score, the effect is often temporary. And for borrowers with federal student loans in default, the Fresh Start program could give them a clean slate, removing the default from their credit reports.
If you receive a 1099-C, TurboTax Premier will guide you through the proper questions regarding your cancellation and make the proper entries on the correct forms so you are not taxed if the cancellation of debt is related to your principal residence.