You’re already so deep in debt you can hardly see out of the hole.
Then, you get hit with the most dreaded form that the IRS publishes: Form 1099-C, Cancellation of Debt.
What you thought was good news—your creditors deciding to give you a break and forgive either all or a substantial part of your debt—just turned into a nightmare.
All that debt you thought you had escaped just came back as something so poorly understood that most people have never even heard of it: debt income.
So now, instead of owing money to your creditors, you owe it to the IRS. Is your blood running cold, yet?
At first, it may not seem to make any sense at all. Why should you have to pay tax on canceled debt? In the case of Form 1099-C, that debt doesn’t really go away—not as far as the IRS is concerned.
Instead, it’s been transformed into a form of income, taxable income.
It doesn’t seem fair, does it? You have little or no ability to pay your way out of debt, and now the IRS has their hand out—and unlike other creditors, the IRS doesn’t negotiate, and they never go away. What do you do next?
Why Are You Getting a Form 1099-C in the First Place?
Most likely, you negotiated with your lender to cancel or reduce your debt because there was just no way you could ever repay it.
You thought you were in the clear or at least headed in the right direction, and then you receive Form 1099-C—but not from the IRS.
Your lender—the one who agreed to give you a break on the debt you owed them—is responsible for sending the 1099-C.
Once you receive one, you’re then responsible for reporting the amount on that form to the Internal Revenue Service as taxable income. Some exceptions do apply, and we’ll get to them.
It’s important to know that all creditors who cancel a debt of $600 or more are required, by law, to report the debt discharge.
They do that by filling out the dreaded 1099-C and sending it to you. It’s then incumbent on you to contact the IRS to report the “debt income” that you’ve just received from your former creditor.
So, that 1099-C that you received isn’t exactly an official government form, and it’s certainly not from the IRS.
It’s your creditor—not the IRS—who fills out and sends the 1099-C, and any information on that form originated with them.
If you identify a discrepancy, disagree with the sum they’ve quoted, or see anything else amiss, your first step is to contact the creditor who issued it.
Was the debt your creditor is claiming discharged by a bankruptcy filing? That’s something that needs to be addressed; your creditor can’t include those debts due to the way bankruptcy law works.
Is the fair market value of the security correct? Maybe the dollar figure of the debt reported on the 1099-C is correct, but whatever you borrowed that money to finance—a new home, for instance—isn’t worth the reported dollar amount.
If this is the case, contact your creditor, report the discrepancy, and try to come to a resolution.
The creditor’s name, address, and telephone number should be in a box on the top left of the 1099-C form. If they’ve made a mistake, they’ll have to issue a new, revised 1099-C with correct information, and send that along.
How Cancelled Debt Turns into Income
It certainly seems unfair that an unmanageable debt that you succeeded in negotiating away comes right back as a tax burden.
As far as the IRS is concerned, when you borrowed money from a lender, for whatever purpose, you didn’t have to pay taxes on it because you were contractually obligated to pay it back.
It wasn’t “income,” it was a loan, which means you never really owned that money. You were borrowing it, and had you been able to pay it back, that money wouldn’t have ever belonged to you. It wouldn’t have been a form of income, and so it wasn’t taxable.
All that changes when a creditor decides to give you a break and release or reduce the amount of debt you owe them.
Suddenly, the money that you borrowed—part or all of which you now will never have to pay back—transforms, as if by magic, into taxable income.
As far as the IRS is concerned, almost any debt you owe a lender that gets canceled, discharged, or forgiven becomes taxable income, and that’s when the dreaded 1099-C shows up in your mailbox.
It may happen if you’ve experienced a foreclosure, repossession of a vehicle, abandonment or the return of property to a lender, or even the modification of a loan on your principal place of residence.
How Debt Income Works
The amount of debt that a creditor is willing to forgive, according to the Internal Revenue Code, qualifies as “debt income. As is the case with virtually every form of income one can receive, it is absolutely taxable.
No matter how large your discharged debt may be, if it’s over that $600 amount, it’s effectively money you received—or income—that hasn’t yet been taxed.
For instance, say you’re $10,000 deep in credit card debt with a bank. After months of negotiations, emails, and phone calls, the credit card issuing bank finally agrees to forgive part of that debt—say $4,000.
Instead of being liable for the full $10,000, you now only have to pay the bank $6,000 (along with any interest charges or fees).
However, that $4,000 they discharged becomes forgiven “debt income,” and once you receive a 1099-C from the bank that issued the credit card in the first place, you now have to report every penny of that four grand as “other income,” right there on Line 21 of the 1040 tax form.
Come mid-April, you could be looking at a hefty tax bill, depending on the amount of debt forgiven, your income level and resulting tax bracket, and the deductions you claim—the IRS, predictably, take it all into account.
Have You Received a 1099-C? You’re Not Alone
The Great Recession—which officially lasted from December of 2007 and didn’t end until June of 2009—resulted in a much larger number of 1099-C debt forgiveness forms being sent to taxpayers.
This, in turn, resulted in more tax revenue sent to the IRS during those years, by people who were already too broke to pay their creditors.
The number of 1099-C forms that made their way to millions of unsuspecting debtors climbed until 2016, which is the first time the number of forgiven or otherwise discharged debts fell since the beginning of the recession.
How Common Is It to Receive a 1099-C?
It’s not terribly common, but it’s far from rare. Using the latest statistics on the subject available from the 2018 update of the IRS Office of Research’s Publication 6961, almost four million 1099-C forms were sent out—and presumably, were filed on or before April 15, 2019.
As the economy continues to stagger along, the amount of consumer debt continues to rise.
By the end of 2018, annual economic growth fell to 2.6 percent, and most economists expect that growth to slow even more during the remainder of 2019 and to continue to fall even further in 2020.
Many economists see a recession looming as early as 2020. What does that likely mean for the amount of discharged debt, and the subsequent number of 1099-Cs that will be sent out?
Unsurprisingly, the number of 1099-Cs being filed is projected to rise to more than 4.3 million for the 2019 tax year, and to continue that rise in 2020, when an estimated 4.8 million—or more—are expected to land in the mailboxes of unsuspecting tax payers, nationwide.
By 2025, the IRS conservatively estimates that the number of 1099-C forms that go out will spike to more than 6.7 million.
Are There Any Ways Around The 1099-C?
Remember when we mentioned certain exceptions that might pertain to your liability to pay the taxes on that “forgiven” debt income? Let’s take a look at a few of those.
The Great Recession that started in 2007 was largely due to the collapse of the real estate market. The magnitude of that collapse resulted in the passage of the Mortgage Forgiveness Debt Relief act by Congress.
The stipulations set forth in that act could result in some relief for some people who have been hit with a 1099-C surprise.
For the calendar years 2007 all the way through 2017, you could exclude up to $2 million in forgiven or discharged mortgage debt, if you were married and filing jointly.
Other filing statuses could exclude up to $1 million in forgiven mortgage debt.
Though the Mortgage Forgiveness Debt Relief Act only specifically covers 2007 through 2017, the exclusionary amount set forth in that act also applies to debt that was discharged in 2018, provided there was a written agreement entered into no later than 2017.
The exclusion also applies to any mortgage debt forgiven through a foreclosure or through a mortgage restructuring.
Insolvency or Bankruptcy Also Provide Exclusion
Bankruptcy, while often traumatic and always a life-altering experience does have its upsides. One of them applies to debt income.
If you had any debt that was discharged in a Title 11 bankruptcy proceeding—like a Chapter 7 or Chapter 13 bankruptcy—you’re not responsible for the taxes on that debt, even if you receive a 1099-C from a creditor. Title 11 bankruptcy protects you from having to pay taxes on any debt thus discharged, as the terms of the bankruptcy invalidate that discharged debt as “debt income.”
Likewise, if you can prove that you were insolvent at the time the debt was canceled, you will not be held liable for paying taxes regardless of whether you receive a 1099-C.
Proving insolvency to the IRS is a lot more straightforward and simpler than it may sound. All you need to do is add up all of your debts—from any source—and subtract them from the value of your assets.
If that number is negative, you were insolvent. Reporting insolvency is done by filing IRS using Form 982.
There are other types of debt which will get you off the hook as far as a 1099-C is concerned.
Qualified farm indebtedness and qualified real property business indebtedness also apply, and if you experience either of those, you can avoid taxation on the forgiven debt.
As we’ve seen, having debt discharged or forgiven is not as simple as it may seem, and could result in a nasty tax surprise.
There are ways around it, provided you qualify via one of the exceptions listed above, but it’s always best to consult an expert.
If you find yourself in the position of receiving a 1099-C or are considering negotiating to have a debt reduced or discharged, do yourself a favor and contact the professionals at Alleviate Financial Solutions.
You can reach us on our website, or via phone at (800) 308-2935. Negotiating with a creditor can go a long way toward getting you debt free—but are you sure you understand all of the implications?
Schedule a free consultation today for a risk-free debt assessment. The only thing you have to lose is your debt.