You decided that it was time to take control of your debt and negotiated it down for pennies on the dollar. Now you're receiving a 1099-C in the mail for the amount that was forgiven. You may be asking yourself what exactly is this for and why am I receiving it?
The 1099-C and What it Means for Your Taxes
If you've received more than $600 in charged off or cancelled debt, the IRS requires that the bank issues you a 1099-C for the amount that was dismissed. The reason behind this is because it was money that you once owed and is now considered income. You are now legally obligated to enter it in your income on your tax return. All is not lost as there is a way around it, one which we'll come to later.
Here's a scenario to explain how it works: You owe a credit card company $8500. The decision is made to eliminate the debt in one fell swoop. You contact the credit card company and make an agreement to settle the amount for $6000. The remaining balance of $2500 is now considered earned income. Taxes are now owed on the $2500 that was cancelled.
Keeping Cancelled Balances From Becoming Income
Ask that the creditor to agree that the debt is paid in full at the time of settlement. Make sure that they do not report the remainder to the IRS. This will stop the forgiven balance from being reported as income.
The standard way to get around the addition to your income is to file a form 982 with your taxes. It's available at www.irs.gov and has the title "Reduction of Tax Attributes Due to Discharge of Indebtedness." Filling out this form tells the IRS that you were insolvent when you entered into the agreement. This does not necessarily mean that you're on the verge of filing bankruptcy. Instead you're demonstrating that your debts outweighed your asset value, thus driving the need to settle your debt. People who are making a median income will see the forgiven amount be dismissed from their income.
Working With A Tax Lawyer
A majority of the time, the IRS takes your information at face value. Or in other words, they take the attitude that you are telling the truth by signing your name to the return. Cancelled debt may be more difficult to negotiate on your own, and you may find that hiring a lawyer will be the best bet to ensuring that you don't have to pay extra taxes.
