Under federal law, a financial entity is required to send a taxpayer a “Form 1099C Cancellation of Debt” whenever it forgives or cancels a loan balance greater than $600. This may create a tax liability for you because the canceled debt is considered “income” for tax purposes. The amount of debt forgiven must be reported on IRS Form 982 (PDF) and this form must be attached to the taxpayer’s tax return.
The financial entity, which may be a federal government agency, a financial institution (such as a bank), a credit union, or "any organization in which a significant part of its trade or business involves the lending of money" may issue a Form 1099C because Freedom Debt Relief negotiated a savings of more than $600 on a debt you had with a creditor.
You may have the ability to reduce or eliminate this so-called Cancellation of Debt Income (CODI) if you were insolvent immediately before the cancellation. For the purposes of completing Form 982, the IRS considers a taxpayer insolvent if the total of all of the person’s liabilities exceeded the fair-market value (FMV) of all of that person’s assets. To determine insolvency, assets include the value of everything the taxpayer owns (including assets that serve as collateral for debt and exempt assets which are beyond the reach of creditors under the law, such as interest in a pension plan and the value of a retirement account). Liabilities include:
- The entire amount of recourse debts, and
- The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt.
Here are two hypothetical examples the IRS uses to describe the cancellation of debt income concept:
Greg was released from his obligation to pay his personal credit card debt in the amount of $5,000. Greg received a Form 1099C from his credit card lender showing canceled debt of $5,000. Greg’s total liabilities immediately before the cancellation were $15,000 and the FMV of his total assets immediately before the cancellation was $7,000. This means that immediately before the cancellation, Greg was insolvent to the extent of $8,000 ($15,000 total liabilities minus $7,000 FMV of his total assets). Because the amount by which Greg was insolvent immediately before the cancellation exceeds the amount of his debt canceled, Greg can exclude the entire $5,000 canceled debt from income.
Assuming the same facts as above, let us say that Greg’s total liabilities immediately before the cancellation were $10,000 and the FMV of his total assets immediately before the cancellation were $7,000. In this example, Greg is insolvent to the extent of $3,000 ($10,000 total liabilities minus $7,000 FMV of his total assets) immediately before the cancellation. Because the amount of the canceled debt exceeds the amount by which Greg was insolvent immediately before the cancellation, Greg can exclude only $3,000 of the $5,000 canceled debt from income under the insolvency exclusion.
More Information on Cancellation of Debt Income
The Internal Revenue Service document Publication 4681 contains more information on the tax consequences of canceled debt. It also contains specific instructions on how to complete Form 982.
If you receive a 1099C keep it with your other tax documents. Be certain to give the 1099C to your tax preparer, and give the tax preparer information regarding your total liabilities and the FMV of your assets as they were immediately before the cancellation.
Mortgage Forgiveness Debt Relief Act
I realize your cancellation of debt income question is not related to a mortgage, but I am mentioning the Mortgage Forgiveness Debt Relief Act in case you have heard about a federal program that forgives debts and are curious about it. The Mortgage Forgiveness Debt Relief Act provides tax relief for mortgage loans on primary residences forgiven in 2007 through 2012. See the IRS document “The Mortgage Forgiveness Debt Relief Act and Debt Cancellation” for more information. Again, this program does not help you with your debts settled with a debt negotiation, consolidation, or resolution program.
If your debts are causing you financial distress, access the Bills.com debt saving center to get no-cost quotes from pre-screened service providers.
I hope this information helps you Find. Learn & Save.