When you go through the process of debt settlement, you’ll end up with canceled debt. This canceled debt will affect how you file your taxes. Your creditor will send you a 1099-C form, which you will need when you file.
Filing taxes can be tricky as it is. Adding canceled debt into the mix only further complicates things. Here’s what you need to know if you’ve received a 1099-C.
Why Do You Need To Pay Taxes On Canceled Debt?
When you have a debt, you are obligated to repay it. However, through the process of negotiation or debt settlement, you may be able to have some of your debt canceled. But, because you were obligated to repay that money, canceled debt over $600 is considered income. As a result, the creditor will send you a 1099-C form, detailing the debt they canceled. You will need to report this on your taxes as income. The creditor also reports the canceled debt to the IRS. So you should not ignore the 1099-C form if you receive it. The IRS is expecting that income to be reported. If you don’t report it, you could get a call from the IRS or an audit notice.
Are There Exceptions?
There are certain exceptions when canceled debt does not count as income. If the debt was forgiven as the result of a gift or inheritance, it is excluded. Debt canceled as a result of insolvency – or having more debt than you have assets – can also be an exception. If you’ve gone through Title 11 bankruptcy and had debt canceled, this may also be excluded. However, if you had debt canceled before you filed for bankruptcy, you will still receive a 1099-C. Some qualifying student loan debt may also be excepted if you’ve been making payments for a certain period of time. If you qualify for an exception, you’ll have to file a separate form – Form 982.
What If I Pay Taxes On Debt That Was Excluded?
If you receive a 1099-C and file accordingly but find out later you may have qualified for an exception or an exclusion, you can correct the error. You have the option to amend your tax return for up to three years. If you did, in fact, report the income erroneously, you may receive a refund. To amend a return, collect all the documents you need. You will need to fill out a Form 1040X. Then, you’ll need to mail the documents to the IRS. You cannot e-file an amendment to a return.
What If My 1099-C is Incorrect?
If you have canceled debt, but the 1099-C you receive is incorrect, you are still required to report the income on your taxes. If the creditor sends a form with incorrect information or sends a form and then continues to try to collect your debt, contact the creditor. You’re required to report this income for the year for which you received the 1099-C. Therefore, you’ll want to get the situation squared away with your creditor before you file your taxes.
Changes for 2019
While a number of changes took hold to tax law in 2019, not much affected canceled debt. The only change applicable involved an exclusion. Previously, up to $2 million of principal residence indebtedness could be excluded. However, that exclusion expired at the beginning of 2018.
Getting debt canceled can be extremely beneficial to your overall financial situation. However, when you’re paying less than what you owed, you may face some ramifications. Debt that is canceled from debt settlement is likely to be taxed as income. If you receive a 1099-C form from a creditor, you will need to take action. Determine whether you are eligible for an exception or an exclusion. Confirm that the information on the form is correct. Because filing taxes can already be confusing, you may wish to seek the help of a professional if you have canceled debt.
Leslie H. Tayne, Esq. and the debt professionals at Tayne Law Group can help you understand the effects of debt cancelation. Call Tayne Law Group today!