Cancellation of debt is the forgiveness of debt obligations by a creditor. Debt relief can be achieved through direct negotiations, debt relief programs, or bankruptcy. Canceled debt is generally considered taxable income that must be reported, but there are many exceptions.
Most negative information generally stays on credit reports for 7 years. Bankruptcy stays on your Equifax credit report for 7 to 10 years, depending on the bankruptcy type. Closed accounts paid as agreed stay on your Equifax credit report for up to 10 years.
In general, if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable. If taxable, you must report the canceled debt on your tax return for the year in which the cancellation occurred.
Using debt settlement options to reduce debt comes with several risks, including late payments on your credit report, potential charge-offs, settlement company fees, tax implications on forgiven balances, possible scams and the overall risk of settlement offers not working.
Credit Card Companies Sometimes Write Off the Debt
If you stop paying on your credit card debt and become seriously delinquent, the credit card company will likely write off the debt and consider it uncollectible. At that point, the company takes your debt off its books.
Since credit history generally makes up 15% of your total credit score calculation,7 closing a credit card account can lead to a change in your score — and in some cases for the worse. With one less account on your file, it can shrink the average age of your credit accounts, causing your rating to drop.
When an account is closed, the amount of available credit decreases, which impacts your credit-utilization ratio — the amount you owe as a percentage of your total available credit. This ratio accounts for 30% of your credit score. Keeping your balances around 30% or less of your available credit is best.
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.
You must file a dispute in writing with each of the three bureaus separately and include supporting documents. The credit bureau will investigate, and the negative item must either be confirmed or corrected. Note that an item may be updated but not entirely removed from your credit report. Pursue a "goodwill" deletion.
In most situations, if you receive a Form 1099-C, "Cancellation of Debt," from the lender that forgave the debt, you'll have to report the amount of cancelled debt on your tax return as taxable income.
Even if you didn't receive a Form 1099-C, you must report canceled debt as gross income on your tax return unless one of the exceptions or exclusions described later applies.
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.
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.
A 609 dispute letter is actually not a dispute but is simply a way of requesting that the credit bureaus provide you with certain documentation that substantiates the authenticity of the bureaus' reporting.
If the creditor doesn't send it before the tax deadline so you can file with the correct information, you'll need to file an amended return when you receive it. Though receiving a 1099-C doesn't hurt your credit, the canceled debt that led to it probably will.
Does credit card debt go away after 7 years? Most negative items on your credit report, including unpaid debts, charge-offs, or late payments, will fall off your credit report seven years after the date of the first missed payment. However, it's important to remember that you'll still owe the creditor.
You cannot remove collections from your credit report without paying if the information is accurate, but a collection account will fall off your credit report after 7 years whether you pay the balance or not.
Debt forgiveness can be a great tool in the right circumstances. For credit card debt, lenders may require you to pay part of the debt, then forgive the rest. Debt forgiveness can relieve financial stress, but keep in mind your credit score may suffer and your tax bill may increase.
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.
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.
What is a 1099-C? 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.
Understanding the Impact of Credit Utilization Ratio
Credit experts advise against closing credit cards, even when you're not using them, for good reason.
Can you reopen a closed Capital One credit card? In most cases, once an account has been closed, it is a permanent move. It's very rare for Capital One to be able to reopen an account once it has closed.
In general, it's better to leave your credit cards open with a zero balance instead of canceling them. This is true even if they aren't being used as open credit cards allow you to maintain a lower overall credit utilization ratio and will allow your credit history to stay on your report for longer.