About Form 1099-C, Cancellation of Debt

  Banking and Finance

Why is it required to file 1099-C?

A 1099-C reports Cancellation of Debt Income (CODI) to the IRS. According to the IRS, if a debt is canceled, forgiven or discharged, you must include the canceled amount in your gross income and pay taxes on that “income,” unless you qualify for an exclusion or exception. Creditors who forgive $600 or more of debt for you, are required to file Form 1099-C with the IRS.

A 1099-C falls under the 1099 tax form series of information returns for the Internal Revenue Service (IRS). These forms let the IRS know you’ve received income outside of your W-2 income. Any company that pays an individual $600 or more in a year is required to send the recipient a 1099. You often receive a 1099-C when $600 or more of your debt is forgiven or discharged.

When you get a 1099-C, you can find the reason you received it in the sixth box of the form. Some common reasons you may get a 1099-C are included below:

  1. You negotiated a settlement to pay a debt for less than the amount you owed and the creditor forgave the rest.
  2. You owned a home that went into foreclosure and there was a forgiven deficiency (a difference between the home’s value and what you owe on it).
  3. You sold a home in a short sale where the lender agreed to accept less than the full amount you owe.
  4. You didn’t pay anything on a debt for at least three years and there has been no collection activity in the past year.

How the IRS classifies cancelled debt

You might consider it unfair that a debt you successfully cancel or negotiate away comes back to haunt you as taxable income. However, the IRS classifies cancelled debt as income because you received a benefit without paying for it.

When you first borrow money, you don’t have to pay tax on the money you receive because you are bound by a contract to pay it back. Once that contract no longer exists, the money is yours to do with as you please. Since you essentially received money for free, the cancellation of your obligation to pay it back makes it taxable income.

Mortgage forgiveness debt relief act

Due to the magnitude of the real estate market collapse that began in 2007, Congress passed the Mortgage Forgiveness Debt Relief Act in 2007. For calendar years 2007 through 2019, you can exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly—up to $1 million for other filing statuses. This also applies to debt that was discharged in 2020 provided that there was a written agreement entered into in 2019. This exclusion also applies to mortgage debt forgiven through a mortgage restructuring or in connection with a foreclosure.

Bankruptcy and insolvency

Even if you receive a Form 1099-C from a lender, you still may be able to avoid taxation on the forgiveness of a debt. If your debt was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case, you’re not responsible for taxes on that debt.

If you can demonstrate to the IRS that you were insolvent at the time the debt was cancelled, you can similarly avoid taxes on that debt. Certain other types of debt, including qualified farm indebtedness and qualified real property business indebtedness, can also avoid taxation in the event of cancellation.

Why Are Debts Cancelled?

The lender may cancel your debt for a number of reasons:

  1. The statute of limitations expired.
  2. You’ve made a debt settlement agreement to pay part of the debt and have the other part canceled.
  3. The lender has a business policy of discontinuing collection activity after a certain period of time.

Of course, finding out your debt was canceled should be a good thing. And once you’ve dealt with the taxes related to the canceled debt, you’ll have no more liability related to that particular debt.

Tax Income Reporting Exclusions

There are certain situations in which your debt can be canceled, but you don’t have to report it as taxable income. If the debt was discharged in bankruptcy (unless the debt was incurred for business or investment purposes) there is not a reporting requirement.

Also, the IRS will overlook student loans that are forgiven by an educational institution that is tax-exempt. However, they require you to have worked for a certain number of years for a qualified employer.

Should I Pay Taxes on the 1099-C Amount?

The IRS will automatically assume that the amount listed on the 1099-C is accurate and will expect you to include that amount in your ordinary income when you file your tax return. Depending on the other income you earn and your tax bracket, you could receive a larger tax bill or a smaller refund. However, if you can demonstrate that you qualify for an exclusion or exception, you may be able to avoid paying taxes on part or all of that phantom income.

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About Form 1099-C, Cancellation of Debt
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About Form 1099-C, Cancellation of Debt
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A 1099-C reports Cancellation of Debt Income (CODI) to the IRS. According to the IRS, if a debt is canceled, forgiven or discharged, you must include the canceled amount in your gross income and pay taxes on that “income,” unless you qualify for an exclusion or exception. Creditors who forgive $600 or more of debt for you are required to file Form 1099-C with the IRS.
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Plianced Inc.
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