Often times, people go through tough times and stop paying with credit cards. After a while, the account can go to a third-party debt collector who could offer a debt settlement for 30-40% of the original sum. Once it is paid, the debtor often thinks the matter is closed, but it is not! The creditor will most likely issue a 1099-C. This is a notice to the IRS of the debt forgiven. If the debtor does not address this on their return, they may receive a bill from the IRS a year or two later with penalties and interest.
A home foreclosure can also result in a 1099-C from the mortgage lender if the property sells for less than the loan amount. In this case, a person loses their home and may also face a tax bill. The invoice typically arrives many months after the tax return was filed as a result of an IRS document comparison program. This “subreport” notice brings pain to the taxpayer.
The key question is whether the debtor was insolvent or not. If they were insolvent, they may not be taxed depending on the circumstances. There is an “insolvency exclusion.” It is insolvent when, and to the extent, its liabilities exceed the fair market value of its assets. Therefore, none of your forgiven debts may be taxed, or all or part of it may be counted as income.
You may not have any 1099C taxable income, but you must account for it on your return. The question is whether or not he was solvent at the time of the cancellation of the debt. You only owe taxes on forgiven debt to the extent that you are solvent. For example, if the forgiven debt was $ 10,000 but you are only worth $ 5,000; You would only be liable for income tax on that amount. A foreclosure is complicated and you may have other legal arguments in addition to insolvency.
There are five situations in which a canceled debt does not have to be reported as income:
Bankruptcy – The debt has already been paid off through bankruptcy proceedings.
Bad debt – Your total debts exceed your total assets at the time they were settled or deemed uncollectible.
The indebtedness is due to a qualified agricultural expenditure.
The indebtedness is due to certain commercial real estate losses.
Your debt forgiveness was treated as a gift (you owed Mom $ 10K and she said “Don’t worry honey, consider it a gift”).
If you are insolvent, you must explain this to the IRS on your tax return. You can complete IRS Form 982: Reduction of Tax Attributes Due to Debt Forgiveness or attach an itemized letter to your tax return explaining the calculation of your total debts and assets.
Don’t ignore 1099-C! Failure to address the 1099C will result in an IRS tax assessment for any amount over $ 600 plus penalties and interest. This is likely to occur 12 to 18 months after your filing, when the IRS matches the information provided to them with that on your tax return. Ask a tax professional to file your return and he or she can help you determine how much of the 1099-C is taxable.
If you get a letter from the IRS on a 1099-C that you left out of your return, get help as soon as possible. Otherwise, the IRS could file a federal tax lien and take action. Find a CPA, Enrolled Agent, Accredited Tax Advisor, Accredited Tax Preparer, or Tax Attorney to help you with a serious tax problem. You can also call the IRS at 1-800-829-1040 for help.
Websites you can check out include:
http://www.irs.gov
http://www.nsacct.org