Will you owe the IRS any taxes if you receive a 1099-C? The short answer is, “it depends.”
You might wonder:
- Why you received a 1099-C
- How much in taxes, if any, you may owe
- 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.
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.
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
|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.
|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.
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.
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