Credit Card Forgiveness and the 1099-C
You breathe a sigh of relief. You have just successfully negotiated a debt settlement agreement with one of your creditors. They agreed to receive $10,000 for the $25,000 credit card debt you originally owed to them and consider it as full payment of your account. But before you open that bottle of champagne, there is something you need to know: The taxman will be coming with a 1099-C. In plain and simple language, the debt which you have been forgiven is considered taxable income.
The Internal Revenue Service (IRS) states that cancellation of debt is taxable as ordinary income. This is provided for under Section 61 (a)(12) of the Internal Revenue Code which states that “income from discharge of indebtedness” is considered gross income and is thus taxable. This happens when a creditor cancels at least $600 of the debt you owe them without receiving anything in return. So in our example above, the $15,000 which was forgiven will have to be reported in the 1099-C, also known as the Cancellation of Debt form.
Cancelled debts owed to a financial institution, the Federal government, a credit union, a military department, the U.S. Postal Service, or any organization having a significant trade or business of lending money need to be reported in the 1099-C. Aside from credit card debt, a COD can also arise when you foreclose your personal residence or cancel an automobile loan.
How can the IRS trace a COD? Lenders report it to them. Now don’t take this personally. It is common practice for creditors to report uncollectible debts, charge-offs, and debts settled for less than the full payment to reduce their tax liabilities. The income that they have declared lost, however, has serious ramifications for the taxpayer as it could mean a sizable tax bill when mid-April comes around.
Not all consumers are apprised of the 1099-C. In fact, many of them simply ignore or trash these notices since these are usually sent by creditors or debt collection agencies to the debtors. They believe that these COD forms are not anymore necessary inasmuch as they have already settled their accounts with these lenders and have the papers to prove it. Because they don’t file it together with their federal income tax returns, they risk not only penalties and fines but audits from the Internal Revenue Service.
Accuracy is one of the things that consumers should be vigilant about when it comes to filling out their 1099-C. You may have agreed to settle your debt for $10,000 but the lender reflected a settlement amount of $15,000 in the COD form. In all likelihood, they factored in all the costs involved in getting the debt lowered. You should contact the lender first if there is a discrepancy in what is reflected in the 1099 and the amount of debt settlement that you agreed with the lender. You can dispute the fair market value written on the form provided that you have information from reliable sources to support your claim. Otherwise, the IRS will take what is given by the form to be correct. A forgiven amount that is higher than what was agreed upon during the debt settlement might result in you having to pay more taxes than you should.
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