If you have reached a settlement agreement with a creditor to repay a debt for less than the balance due, the Internal Revenue Service calls this "canceled" debt.
Under federal tax law, forgiven or canceled debt is considered income for tax purposes. Accordingly, a creditor is required to submit a 1099C to the IRS for any debt forgiveness exceeding $600 in value. Therefore, a consumer would be wise to consult with a certified tax preparer, CPA, or tax attorney with respect to the implications of being taxed on the forgiven debt.
Generally speaking, many creditors do not issue 1099Cs, and as a result consumers do not pay additional taxes on the forgiven debt. Many consumers who do receive 1099Cs do not see a significant tax penalty because of their severe financial hardships.
Taxpayers that meet the IRS financial hardship test on the IRS Form 982 will not have to declare the forgiven debt as income, even if they receive a 1099C for edebt forgiveness.
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