IRS Form 1099-C: Cancellation of Debt and Insolvency Exclusion
Overview
This statement is designed to provide information and instruction for individuals who have received a Cancellation of Debt Form1099-C.If you have reached a compromise or settlement with a creditor agreeing to release you from any further obligations regarding the repayment of a debt, a credit card debt for example, your responsibilities may not end at this point. Your creditor may “write off” all or part of the debt it claims that you owe, and report it as a tax loss to the IRS using a 1099-C.Because you never paid the debt in full, the IRS can treat a cancellation of a debt as income you have received. For example, a $4,500 credit card bill in which a compromise has been reached between you and the lender to settle the debt for $2,500, is in theory a $2,000 personal net gain. The IRS may require you to report this cancelled debt as income you have received for the tax year even though you have not actually received the money.
What is a 1099-C – Cancellation of Debt form?
A Form 1099-C lets you know that a creditor is going to “write off” the remaining unpaid portion of your debt. Form 1099-C, Cancellation of Debt,is filed by a creditor to the IRS when a settlement agreement between you, the debtor and the creditor has been reached or when the creditor has determined that a debt will never be paid. If the debt is for $600 or more the creditor must send you, the debtor, a Form 1099-C in the mail by January 31st and to the IRS by February 28th of the tax year in which the debt was discharged.
Why did I receive a 1099-C: Cancellation of Debt form?
If you have defaulted (failed to make payments as agreed) on a debt in the past and you have either reached a compromise with a creditor to settle your debt, or the creditor has deemed the debt to be non-collectable and has stopped its attempts to recover rhe debt, you may receive a 1099-C form. The IRS definition of a compromise in a collection case is the discharge of indebtedness under an agreement between the creditor and the debtor to cancel the debt at less than full consideration.
What should I do after I receive a 1099-C: Cancellation of Debt form?
If you receive a 1099-C form from a creditor, you must report the amount of the canceled debt as income to the IRS even though you have not actually received the money. (The amount shown in Box 2 of the 1099-C form is the amount that must be reported as income.)
What debts are forgiven under a 1099-C: Cancellation of Debt form?
The IRS recognizes five situations where a cancelled debt does not have to be reported as income.
- Bankruptcy – the debt was already discharged through a bankruptcy proceeding. (call for details)
- Insolvency – total debts exceed total assets at the time the debt was settled or deemedas non-collectible. (call for details)
- Indebtedness is due to a qualified farm expense.
- Indebtedness is due to certain real property business losses. (call!)
- A giftdischarged when the debt was treated as such. (very rare)
How do I know if I am insolvent?
You are deemed to be insolvent if your total liabilities (debts) are greater than your total assets. Completing the insolvency worksheet at the bottom of this document will help you determine if you were insolvent at the time your debt was discharged. For example, if your total liabilities are $8,000 and your total assets at the time are $6,000 you are insolvent in the amount of $2,000. To determine the value of your assets use the fair market value rather than what you paid for them or what you think they are worth.
If you are insolvent you need to explain this to the IRS in one of two ways.
- By filing IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, or
- Attaching a detailed letter to your tax return explaining the calculation of your total debts and assets.
Helpful tips to avoid problems if you have received a 1099-C.
- If you settle your debt for less than full consideration (paid in full) be sure to ask the creditor if they intend to submit a 1099-C form to the IRS.
- Consider, if a debt compromise is in your best interest, or is it a smarter decision to pay the debt in full? Failure to report added income could end up costing you in the end.
- The name of the creditor may not be readily recognizable on the 1099-C form. The creditor may have sold the debt to a third party collection agency or the name of the parent company could be listed as the creditor.
- Look to see if the added income received from a debt cancellation will move you into a higher tax bracket. For a taxpayer in the 35% tax bracket, a $5,000 canceled debt could cost up to $1,750 in additional income taxes.
- You cannot claim that you never received a 1099-C form in the mail. Even if you do not receive a 1099-C form you are expected to recognize a capital gain.
IMPORTANT: For individuals receiving public benefits and public housing, be sure to check if your updated income will exclude you from the benefits you are receiving.
Statement of Total Assets and Liabilities To Determine Insolvency
To Determine Insolvency:
Name:________________________________________________________
SS #:_________________________________________________________
Tax Year:_____________________________________________________
Assets as of:__________________________________________________
Liabilities as of: ________________________________________________
Home: $______________________________________________________
Credit Card Debt: $_____________________________________________
Car: $_______________________________________________________
Mortgage:$___________________________________________________
Bank Accounts:$____________________________________________
Loans: $___________________________________________________
Personal Property:$___________________________________________
Car Payments: $_______________________________________________
Other:$______________________________________________________
Other:$______________________________________________________
Other:$______________________________________________________
Other:$_____________________________________________________
Other:$_____________________________________________________
Other:$_____________________________________________________
TOTAL ASSETS: $_____________________________________________
TOTAL LIABILITIES: $_________________________________________
TOTAL LIABILITIES – TOTAL ASSETS = $ __________________________
(Amount of Insolvency)
(Note: In order to be insolvent total liabilities must be greater than total assets.)
Legal Terms
Creditor – A person or corporation to whom a debt is owing by another person who is the “debtor.”
Debtor – One who owes a debt to a creditor.
Write off – To cancel from accounts as a loss.
Default – To fail to pay money when it is due.
Fair Market Value – Price at which a willing seller and a willing buyer will trade.
Net Gain – An increase in the value of a capital asset.
If you are facing this horrific issue with the IRS, please do not put it off any longer! Call our office for a comprehensive solution to this nightmare. We will work with you until your tax issue is completely resolved! We guarantee it!
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