Ask Bill your personal finance question

Cancellation of Debt Income & Form 982

My debt resolution company saved me a lot of money on my debts. Will I owe taxes on cancellation of debt income (CODI)?

I recently settled on my debts through Freedom Debt Relief and I want to know if I will owe taxes from any cancellation of debt income (CODI) or if I will be 1099 taxed for the big savings I received.

Read full question
Bill's Answer
100 Comments
4.5
/5.0
(14 Votes)

Updated: Feb 12, 2014

Debt Counseling - Couple
Highlights

  • How a cancelled debt can lead to a tax obligation.
  • You may be able to avoid declaring cancelled debt as income.
  • Consult with a tax professional, whenever you have debt cancelled.

Will you owe the IRS any taxes if you receive a 1099-C? The short answer is, “it depends.”

You might wonder:

  1. Why you received a 1099-C
  2. How much in taxes, if any, you may owe
  3. If you can avoid paying taxes

Learn how to handle a 1099-C and how to calculate taxes you may owe. You might be able to avoid taxes by following a process the IRS calls cancellation of debt income (CODI). Read on to learn more about your 1099-C and how CODI might keep your tax bill under control.

What’s a 1099-C, and Why Did Someone Send Me One?

Under federal law, a person or business with “a significant trade or business of lending money” must send a taxpayer a “Form 1099C Cancellation of Debt” whenever it forgives or cancels a debt greater than $600. This may create a tax liability for you because the cancelled debt is considered “income” for tax purposes. The amount of debt forgiven must be reported on a IRS Form 982 (PDF) and this form must be attached to your tax return.

The organization that sends you a 1099-C may be a bank, credit union, or even a federal government agency (such as the USDA) that lent you money, then cancelled the debt. You might receive a 1099-C if debt settlement business such as Freedom Debt Relief negotiated a savings of more than $600 on a debt you had with a credit card issuer. A collection agent may not send you a 1099-C.

The 1099-C is probably the most misleadingly named IRS form. Even though the IRS calls it the “1099-C, Cancellation of Debt”, this form does not mean the debt is forgiven, deleted, forgotten, or is no longer collectible. It is possible for an original creditor that issues a 1099-C to sell your account to a collection agent. The collection agent may collect a debt on which a 1099-C was issued.

How Much Do I Owe In Taxes?

You must include the amount mentioned in your 1099-C as income when you file your income taxes. As mentioned, you disclose the 1099-C information by completing a Form 982 and including the 982 the next time you file your income taxes. A 1099-C is not a tax bill, but it can have a significant impact on your tax situation if the amount is large.

If your debts cause you financial distress, talk to a Bills.com debt resolution partner to learn your options to resolve your debt.

How to Avoid Taxes Caused By a 1099-C With CODI

You may reduce or eliminate your taxes due through a procedure the IRS calls a Cancellation of Debt Income (CODI). CODI applies if you were insolvent immediately before the cancellation occurred. You calculate CODI by completing a Form 982.

For the purposes of completing Form 982, the IRS considers you insolvent if the total of all your liabilities exceeded the fair-market value (FMV) of all your assets. To determine insolvency, assets include the value of everything you own (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 had an unpaid $5,000 credit card debt. Greg’s credit card lender sends him a Form 1099-C showing a cancelled 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 were $7,000. This means 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 cancelled, Greg can exclude the entire $5,000 cancelled debt from income.

Now let’s change a few facts. Let us say 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 cancelled debt exceeds the amount by which Greg was insolvent immediately before the cancellation, Greg can exclude only $3,000 of the $5,000 cancelled debt from income under the insolvency exclusion.

Cancellation of Debt Income Worksheet
  Total Liabilities   Asset Fair Market Value   Insolvency Amount
How Much Can Be Excluded From Income
How the IRS calculates your insolvency. Source: IRS & Bills.com
Greg Example No. 1 $15,000  -  $7,000  =  $8,000
Because this exceeds the amount of cancelled debt, Greg can exclude the entire $5,000 shown on his 1099-C.
Greg Example No. 2 $10,000  -  $7,000  =  $3,000
Because this is less than the amount of cancelled debt, Greg can exclude only $3,000 of the $5,000 shown on his 1099-C.
You    -     =   
Note See IRS Publication 4681 for more information and instructions on how to complete a Form 982

More Information on Cancellation of Debt Income

The Internal Revenue Service document Publication 4681 contains more information on the tax consequences of cancelled debt. It also contains specific instructions on how to complete Form 982, and more hypothetical examples.

If you receive a 1099-C, keep it with your other tax documents. Give the 1099-C 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.

IRS problem? Talk to a Bills.com tax resolution partner to learn how you can negotiate a settlement to your tax issue.

Mortgage Forgiveness Debt Relief Act

You may have heard about the Mortgage Forgiveness Debt Relief Act. MFDRA was in effect until the end of 2013. As of this writing, Congress has not extended MFDRA, but it did so in 2013 when MFDRA expired at the end of 2012. If your 1099-C relates to a mortgage debt cancelled in 2013 or before, MFDRA may apply to you.

The Mortgage Forgiveness Debt Relief Act provides tax relief for mortgage loans on primary residences forgiven in 2007 through 2013. See the IRS document The Mortgage Forgiveness Debt Relief Act and Debt Cancellation for more information. MFDRA does not help you with credit card or similar personal debts settled with a debt negotiation, consolidation, or resolution program.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

100 Comments

Recent Best
1500 characters remaining
  • JG
    Apr, 2014
    Jerry
    This year, my wife received a 1099-C after a student loan debt was cancelled in 2013 for health reasons. Is this taxable income on the federal level? Should we have been paying quarterly taxes in 2013 if it was taxable?
    0 Votes

    • BA
      Apr, 2014
      Bill
      Debt that was forgiven in 2013 will need to be included in the 2013 taxes. I don't believe that there is any need to pay estimated taxes on this kind of tax debt. I suggest that you speak with a tax professional, to see if you can avoid paying taxes on the forgiven debt. You have to meet the IRS standards for hardship, so see if the tax pro believes you meet that test.
      0 Votes

  • AM
    Mar, 2014
    Amanda
    If I borrowed $1million to buy a building & my note was forgive by $300,000 & at the time the building was worth $700,000 and I had $50,000 cash on hand. How much COD income must I recognize?
    0 Votes

    • BA
      Mar, 2014
      Bill
      Your hypothetical does not provide enough information to answer your question. What are your total assets? What are your total liabilities?

      Review the two hypothetical situations in the original answer above to understand how to do the math on a CODI question.
      0 Votes

  • DN
    Mar, 2014
    Di
    I have received 2 1099-C. One is for a total of $70K and the other says "Corrected and $0 amount". The student loan is from almost 10 years ago. My parents went thru bankruptcy and now it says canceled. I'm confused on what to do. What form do I use for my taxes?
    0 Votes

    • BA
      Mar, 2014
      Bill
      From what you described, the best advice I can give you is to take the two 1099-Cs to a tax professional for review. The potential tax exposure for not properly declaring $70,000 in income is too great to rely on the advice of someone online.
      0 Votes

  • PM
    Mar, 2014
    Phyl
    I received a letter from the IRS today saying that I did not file a 1099C with my 2012 taxes. They had the loan number on the back from 1st Citizens bank. Amount $6999. Which they added to my 2012 taxes.I have no loans with Frist Citizens, so I called the bank. This loan was from 1995,,,,almost 18yrs ago, and it was a loan that my ex was to pay for solely as per the divorce decree.. but I got a bill for $1800. First of all.... REALLY 18yrs later, and secondly, why should it solely be MY responsibility. Just a few questions I have about this confusing thing....
    0 Votes

    • BA
      Mar, 2014
      Bill
      Consult with a tax lawyer to learn if the 1099-C issue was filed in a timely manner. I agree, 18 years seems like a long time to raise a tax issue, and confess I do not know if there is something like a statute of limitations rule that applies in your particular circumstances.
      0 Votes

  • BG
    Feb, 2014
    Brit
    I received a 1099-C cancellation of debt letter. Does that mean they will take my tax return?
    0 Votes

    • BA
      Feb, 2014
      Bill
      You're jumping ahead a few steps to something you can avoid easily. A tax offset, which is what the federal government calls a tax return garnishment, may not be in the cards for you.

      Complete an IRS Form 982 with your next federal income tax return to learn how your 1099-C may impact you. Consult with a tax preparation professional to learn if CODI can help you avoid tax liability.
      0 Votes