1099C Cancelled Debts - Charged off debt law

"Canceled debt income," often called canceled or forgiven debt, is something anyone with unpaid debts which is not gifted should be concerned with. The IRS considers this income.

Think of it this way; If your credit card company or lender gave you a loan, but you never paid it back, that is income. You received the money. This applies to debts OVER $600.00.

Canceled Debts and Your Federal Tax Returns

Listing your unpaid debts on your federal tax returns is essential, as the IRS requires you to disclose this information. Failure to do so could result in hefty fines and possible criminal charges. When you have unpaid debts sent to collections, the creditor may report the outstanding balance to the IRS as taxable income. This means you must pay taxes on the amount you owe. In addition, you may be assessed late fees and penalties or receive a reduced refund.

In very serious cases, you could be charged with tax evasion if you fail to report your unpaid debt to the IRS. This is a serious crime and can result in jail time. The IRS also has the power to bring a civil suit against you for fraud. In addition, the IRS can file a lien on your property and assets, preventing you from taking out loans or selling any of your assets.

To ensure that you do not get into any trouble with the IRS, it is important to list your unpaid debts on your federal tax returns. This will ensure you don’t get any unpleasant surprises from the IRS. If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest will also be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible if you paid it.

If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from box 2 of Form 1099-C. If the interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the amount shown in box two less the interest amount shown in box 3). 

How does the IRS classify canceled debt?

The IRS generally classifies canceled debt as taxable income. When a lender cancels a debt you owe, they may issue a Form 1099-C, which reports the amount of the canceled debt as taxable income to you. The IRS considers canceled debt income because you received the benefit of the loan or credit but did not repay the total amount borrowed. The canceled debt is therefore treated as income for tax purposes and is subject to federal income tax.

It's important to note that canceled debt may also have state tax implications, and you should consult with a tax professional or accountant for guidance on how to report it on your state tax return. If you receive a Form 1099-C for canceled debt, it's important to carefully review the form to ensure that the amount reported is accurate. You should contact the lender to request a corrected form if you believe the amount reported is incorrect.

Mortgage deductions: the Debt Relief Act

The Mortgage Forgiveness Debt Relief Act (MFDRA) was a federal law enacted in 2007 that provided tax relief to homeowners who had mortgage debt forgiven or canceled due to foreclosure or a short sale. Under the MFDRA, homeowners who had mortgage debt forgiven or canceled between 2007 and 2017 could exclude up to $2 million of the canceled debt from their taxable income. The law applied to both primary residences and second homes but did not apply to investment properties.

Without the MFDRA, canceled mortgage debt would have been treated as taxable income, which could have resulted in a significant tax bill for homeowners who were already in financial distress. The MFDRA has expired and is no longer available for mortgage debt canceled or forgiven after December 31, 2017. However, some homeowners may still be able to exclude canceled mortgage debt from their taxable income using other available exclusions or exceptions, such as insolvency or bankruptcy.

It's important to note that canceled mortgage debt may also have state tax implications. Homeowners should consult with a tax professional or accountant for guidance on reporting it on their state tax returns.

1099-C Exceptions

There are several exceptions to the inclusion of canceled debt in income. These are explained next. 

Nonrecourse debt

If you are not personally liable for the debt (nonrecourse debt), different rules apply. You may gain or lose if a nonrecourse debt is canceled or forgiven in conjunction with the foreclosure or repossession of the property to which the debt attaches. See IRS Publication 544 for more information. 

Student loans

Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if you work for a certain period in certain professions for any of a broad class of employers. You do not have income if your student loan is canceled after agreeing to this provision and performing the required services.

To qualify, the loan must have been made by: 

The federal government, a state or local government, instrumentality, agency, or subdivision thereof is a tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital whose employees are considered public employees under state law or an educational institution.

A loan to refinance a qualified student loan will also qualify if it was made by an educational institution or a tax-exempt 501(a) organization under its program.

Deductible debt

You do not have income from a debt cancellation if your debt payment is deductible. This exception applies only if you use the cash method of accounting. For more information, see Chapter 5 of Publication 334, “Tax Guide for Small Businesses.” 

Price reduced after purchase

Generally, if the seller reduces the amount of debt you owe for the property you purchased, you do not receive income from the reduction. The debt reduction is treated as a purchase price adjustment and reduces your basis in the property. 

Excluded debt: Do not include a canceled debt in your gross income in the following situations. 

• The debt is canceled in a bankruptcy case under Title 11 of the US Code. See Publication 908, Bankruptcy Tax Guide. 

• The debt is canceled when you are insolvent. However, you cannot exclude any canceled debt greater than the amount for which you are insolvent. See Publication 908. 

• The debt is qualified farm debt and is canceled by a qualified person. See Chapter 4 of Publication 225, The Farmer's Tax Guide. 

• The debt is qualified real property business debt. See Chapter 5 of Publication 334.  Download the 1099C form from the IRS (PDF).

If you are unsure if you received this form, check your records or contact the IRS.

Do I need to repay a loan if it was canceled or forgiven because of the COVID pandemic?

If you had a debt canceled or forgiven due to the COVID-19 pandemic, whether you need to pay it back depends on the terms of the agreement between you and the lender. There are various programs and relief measures put in place by the government and private lenders to help individuals and businesses affected by the pandemic, including mortgage forbearance, student loan relief, and small business loan forgiveness. Sometimes, these programs may involve the cancellation or forgiveness of debt.

It's essential to review the terms of the agreement with the lender to determine whether you are required to pay it back or if it was a true cancellation or forgiveness of debt. In some cases, the canceled or forgiven debt may be treated as taxable income by the IRS, which means you may owe taxes on the amount forgiven.

It's also important to note that if you must pay back any portion of the canceled or forgiven debt, you should make arrangements with the lender to do so promptly to avoid any negative consequences, such as damage to your credit score or legal action taken by the lender. If you have any questions about the terms of debt cancellation or forgiveness related to COVID-19, you may want to consult a financial advisor or attorney for guidance.

What is the statute of limitations on a 1099-C?

Generally, there is no statute of limitations on a 1099-C, but the creditor does have to send you the form promptly so that you can include it on your tax returns. There is no rule about how long a creditor has to officially charge off your debt, so it could be years before you receive the form in the mail. There are exclusions to being sent a 1099-C, like bankruptcy or if you settled the debt.

Understanding the Purpose of a 1099-C Form

The 1099-C form is important for both the creditor and the individual who had a debt canceled. For the creditor, it helps to ensure they comply with tax laws and reporting requirements. For the individual, it serves as a reminder that the canceled debt may be taxable as income because this amount enriched you. The IRS uses the information reported on the 1099-C form to determine whether an individual owes taxes on the canceled debt. If the individual does owe taxes, the IRS will typically issue a bill for the amount owed, which may include interest and penalties.

Consequences of Not Sending a 1099-C Form to a Debtor

If a creditor fails to send a 1099-C form to the IRS, they may face the consequences. These may include fines, penalties, and even legal action. Additionally, suppose the individual who had the debt canceled does not report the canceled debt as income on their tax return. In that case, they may face consequences, including fines, penalties, and even legal action.

What if the creditor didn’t send me a 1099-C?

You are still responsible for reporting the unpaid debts as income on your federal tax return. Because a creditor may take time to write off the debt officially, you may not receive the form for a few years, so to avoid penalties, report the debt on your tax return.

The video below explains the 1099-C canceled or forgiven debt IRS rule. Form 1099-C. If a federal government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2 of the IRS form. 

Do I still owe the debt after the creditor wrote it off and sent me a 1099-C?

The creditor writing off a debt and sending you a 1099-C form does not necessarily mean you are relieved of the obligation to repay the debt. When a creditor writes off a debt, they have determined that they are unlikely to collect it and have removed it from their books as an asset. However, the debt still exists, and you may be legally obligated to repay it. The 1099-C form indicates that the creditor has canceled or forgiven the debt, and the amount of the canceled debt may be considered taxable income by the IRS.

It's important to note that even if you receive a 1099-C form for canceled debt, you may still be able to negotiate with the creditor to pay off the debt for a reduced amount or set up a payment plan to repay the debt over time.

How do I fill out a 1099-c form?

1. Determine if the canceled debt is taxable: Not all canceled debt is taxable. For example, canceled debt related to your main home or canceled debt discharged while you are insolvent may be excluded from taxable income. You must review the instructions for Form 1099-C and consult with a tax professional to determine if your canceled debt is taxable if you are unsure.

2. Report the canceled debt on your tax return: Report the amount on your tax return. You will need to include the canceled debt as income on your Form 1040, Schedule 1, Line 8.

3. Complete Form 982: If you are eligible to exclude some or all of the canceled debt from taxable income, you must complete Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment). The form provides instructions on calculating and reporting the exclusion amount on your tax return.

4. File your tax return and pay any taxes owed: Once you have completed all necessary forms and calculated the amount of tax owed, you must file your tax return by the deadline and pay any taxes owed. If you cannot pay the full amount of tax owed, you may be able to set up a payment plan with the IRS.

After the creditor writes off a debt, what is the deadline to file a 1099-c on my taxes?

If a creditor writes off a debt and cancels or forgives $600 or more of the debt, they are required to send the debtor and the IRS a Form 1099-C (Cancellation of Debt) by January 31st of the year following the tax year in which the debt was canceled or forgiven. For example, if a debt were canceled or forgiven in 2022, the creditor would need to send the debtor and the IRS a Form 1099-C by January 31st, 2023.

If the creditor fails to send Form 1099-C or sends an incorrect form, the debtor should contact the creditor to request a corrected form. If the creditor does not respond, the debtor should contact the IRS to report the issue. It's important for debtors to report all taxable canceled debt on their tax return in the year that the debt was canceled or forgiven. Failing to report canceled debt as taxable income can result in penalties and interest from the IRS.

What if I receive a 1099-c form for canceled debt but am on social security or disability?

If you received a Form 1099-C for canceled debt and you are on Social Security or disability, the canceled debt may still be taxable, but there are some circumstances in which it may be excluded from your taxable income. It's important to note that you must determine if you could be exempt under certain exclusions (bankruptcy, insolvency, etc.). Exclusions are complex and may require the assistance of a tax professional or accountant.

What if the person who owes a 1099-c is deceased?

If the person who owes a 1099-C is deceased, the deceased person's estate may be responsible for reporting and paying taxes on the canceled debt. The estate executor or personal representative must file the deceased person's final income tax return, including any taxable canceled debt reported on Form 1099-C. The estate may be able to claim certain deductions and credits to reduce the amount of taxes owed on the canceled debt.

If the estate is unable to pay the total amount of taxes owed on the canceled debt, the IRS may allow the estate to set up a payment plan or offer in compromise to settle the debt for a reduced amount.