I just got off of the phone with Joe. He received a tax document called a 1099-C in the mail from Chase. He has a credit card with Chase that he hasn’t paid in about a year. A month ago, he received a letter from Chase stating they were no longer going to be collecting the debt he owed. He really didn’t think anything of it until he got an IRS form 1099-C. He isn’t sure what impact, if any, this will have on his taxes.
Joe is just the most recent client of mine that received a 1099-C form from Chase, but I have received a lot of phone calls about this matter over the past couple of weeks. A 1099-C is an IRS form that is also called a Cancellation of Debt Income form. If a creditor forgives a debt and promises to never collect it again, the debt is cancelled. This is different from a debt being “written-off,” which usually just means it has been sold to a collection agency. Any cancellation of debt over $600.00 has to be reported to the IRS by the creditor. The 1099-C form is then generated and sent to the person that used to owe the debt.
The general rule is that any debt that is cancelled is considered taxable income. Yes, that means that if Chase cancels a $5,000.00 debt, it is just like you went out and earned another $5,000.00 that year and you might have to pay taxes on that amount just like any other income.
There are a few exceptions that allow you to not have to pay income taxes on cancelled debt. The most commonly used exception is the insolvency exception. In order to qualify for the insolvency exception, you must be able to prove that your debts exceeded your assets on the date that the debt in question was cancelled. Your debts would include mortgages, car loans, student loans, credit cards, medical bills, etc. Your assets include the value of real estate, vehicles, household goods, retirement accounts, bank accounts, investment accounts, etc. If your debts totaled more than your assets on the date the debt was cancelled, you do not have to pay income taxes on it. You must fill out and attach IRS form 982 to your tax return if you are alleging that you should not have to pay taxes on the cancelled debt.
It is important to note that if you file for bankruptcy and have your debt forgiven in the bankruptcy, it is not considered taxable income. Many people that participate in a debt settlement program are shocked when they receive a 1099-C after a settlement is made with a creditor. I have never heard of a debt settlement program that warns participants that they may face tax consequences for trying to pay off their debt for less than the total amount owed. If you are weighing the options of bankruptcy and debt settlement for dealing with your debt, it is important to consider the fact that debt settlement could leave you with a tax bill whereas bankruptcy will not.
If you’ve received an IRS form 1099-C Cancellation of Debt Income form, don’t ignore it. It must be dealt with on your tax return. If you’ve had debt cancelled and can’t afford the resulting tax consequences, give Steidl & Steinberg a call and we can explore the options for you to repay or reduce the amount that you owe to the IRS. If you are in debt and exploring options to deal with the debt, be sure to consider the fact that having debt forgiven in a bankruptcy will not result in you having to pay any income taxes on that debt forgiveness. Give Steidl & Steinberg a call and we can review your situation to see if a bankruptcy would be a good, tax-free way of dealing with your debt.