Relief from debt could be called the modern American dream. Theses days. So many people are in deep debt from a variety of sources, including student loans, medical debt, and credit card or loan debt. Forgiveness of debts is a common incentive for young people to sign up for programs like AmeriCorps and even the military.
However, there are some important facts that many people don’t realize about debt forgiveness – until it’s too late. When your debts are relieved, you no longer have to pay them. However, that lump some of debt relief is legally treated the same way that income is treated in terms of taxation. That means that your debt relief solution may lead to a massive amount of taxes due!
Few things can drop your stomach more than receiving an unexpected 1099-C form in the mail come tax time. When you’ve had a major debt relief in the past year, you can expect one of these forms to show up at your address. It is referred to in the tax industry as ‘COD income’; you will receive a specific 1099-C Cancellation of Debt for credit card or other types of forgiven debts. However, many people not only don’t know that they should expect this – but they also don’t know what to do once they receive the form.
Some people see a large tax amount due from canceled debt and think their only option is to file for bankruptcy. While this is certainly an exception to the obligation to pay taxes on that canceled debt, it is likely unnecessary. What’s more, bankruptcy can have a lasting impact on your credit.
Thankfully, there are other exceptions that can get you out of paying taxes on that debt – and some of them are much simpler than you might imagine!
Some instances do not require the payment of taxes on canceled debt. One example is a total forgiven debt amount of less than $600. In this case, your creditor may opt not to report the amount to the IRS as Cancellation of Debt Income. However, most creditors will report any forgiven debt, so it’s a good idea not to count on this instance.
Some other reasons why you may not have to pay taxes on a canceled debt include:
For other examples of types of debt forgiveness that are not under tax obligations, speak to a bankruptcy attorney in your area.
It is easy to feel panicked when you receive an unexpected 1099-C Cancellation of Debt for credit card or other debts. Don’t. Before allowing yourself to worry, get in touch with a bankruptcy or tax professional and talk through your options. You aren’t necessarily doomed to handing the IRS a large check. You will likely find that you have more choices in the matter than you thought!
Some specific procedures for how to approach your form 1099-C Cancellation of Debt for credit card or other debts include the following:
If you filed for bankruptcy and had your debts discharged, you do not owe taxes on the discharged amount. While this isn’t the solution for everyone, it is a great way to avoid taxation or the obligation for repayment on large amounts of debt. If your total forgiven debt is included in your bankruptcy discharge amount, you won’t owe a single cent in taxes on that total!
In the case of insolvency, things are a little more tricky. You may receive a form 1099-C Cancellation of Debt for a credit card debt that you had canceled – and the amount you are being taxed for might be far in excess of what you actually owed after your insolvency. This is because the reported tax obligation is based on the total amount of debt you were relieved of.
However, this information is not accurate – and your tax preparation professional can help you find the correct total. As a rule of thumb, you can subtract the amount of your insolvency from the total amount of debt owed to find your reported assets. This is the total which you should report as income on your tax forms – and for which you are obligated to pay taxes. In some cases, this total may be as low as zero!
Not all student loan debt forgiveness is free from taxation. However, if you are working in a field-specific position that promised student loan relief as part of your contract, you should not owe any taxes on the forgiven amount. Be sure to check with your employer or the program under which you are employed to find out if this is the case in your instance – or talk to an experienced tax preparation professional.
What happens when your debt is forgiven purely out of the kindness of someone’s heart? Whether it is the forgiveness on the part of a personal acquaintance or as an act of goodwill on the part of your creditor, debt forgiveness as a gift mean that the amount canceled should not be taxed. Be sure to accurately report this instance to your tax preparation team.
For more information about what to do if you receive a form 1099-C for Cancellation of Debt from credit card or other debts this year, talk to the experts at the VanHorn Law Group. With decades of combined experience, the team at VanHorn can help you navigate this confusing process and ensure that you don’t pay a dime more than you have to this tax season!
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