Tax Form 1099-C Requirement And Consequences As Per The Law To Report Cancelled Debt

Most people have a very wrong notion when they opt for debt settlement and this is all due to the ignorance of the different rules and regulations that involve debt and debt relief services. Most people have the most basic knowledge about debt settlement process which is:

• It is a process where the outstanding amount is reduced to get rid of the debt faster and in a convenient way
• Payments can be made in a lump sum or also in monthly installments as per the new terms agreed between the customer and the creditor and
• You may involve a debt settlement company for the negotiation process to achieve the desired results.

However, people often are ignorant about the other aspects of a debt settlement process which are well within the legal peripheries of the debt law. These are:

• The success of the process entirely depends on the creditors who have the legal right to deny such a proposal
• In most of the times it is found that the creditors are less keen to talk to a debt settlement company rather than the customer directly
• If you manage to get your debts settled it will surely harm your credit score and will reflect in your credit history for seven long years
• The creditors have the legal right to sue the customer for non-payment listening to the advice of the debt settlement company apart from adding the legal fees and interests and most importantly
• You may still have to pay taxes as per the IRS rules on the amount of debt forgiven by the creditor in case the settlement negotiation is successful.

It is for this reason that experts’ advice that you go through more than one debt settlement reviews to get the bigger and clear picture of the process, its working as well as the consequences.

The tax requirements

The cancelled debt of the last year will be inevitably become your tax burden this year. Whenever, you cancel or settle a debt for a reduced amount, expect to receive the Form 1099 C. This is the designated form that is sent by the creditor who settled the debt. This form includes the exact amount of your debt forgiven. Taking this into consideration, you must include this forgiven amount as your taxable income when you prepare the federal tax return for this year.

As per the IRS requirement:

• All businesses must send a 1099 C to the consumers if the cancelled or forgiven debt amount is more than $600
• It is not mandatory for the businesses to warn you about tax implications of canceling or forgiving your debts

Such a form will have a huge implication on your tax refund for the current year depending on the amount of debt forgiven or cancelled as well as your other income, exemptions and withholding amount. That means this cancelled or forgiven debt amount will reduce the tax refund you may be due this year and in worse scenarios you may end up owing more taxes to the IRS due to your cancelled debt.

Reasons for debt cancellation

Debts are often cancelled by a lender in a number of situations and for several reasons such as:

• The statute of limitations may have expired
• You may have made a debt settlement agreement with the lender to pay a part of the debt and have the other part cancelled or
• The creditors may follow a specific business policy of discontinuing their collection activity after a definite period of time.

No matter how impressive these reasons may sound the consequences regarding the tax implications still remains the same.

Such forgiven or cancelled debt amount is considered as your taxable income because when you borrow money you typically enter into an agreement with the lender to return it along with interest, which is their earning on the money extended to you on good faith. At this point this is not considered as your money and therefore it is not subject to taxation.

On cancellation of the debt by the lender, the money saved or not paid by you becomes yours and therefore considered as your income.

Tax income reporting

Therefore, when you receive a 1099 C form from any of your creditors, do not throw it in the dustbin. The fact that you have received this form means that the IRS has also received it because the creditor will also send a copy of it to them. Therefore, the IRS will expect that you include this amount as your taxable income when you file your next tax return.

Meet a tax preparer and insist that the 1099 C form is included with all other financial documents. Remember, all tax preparers may not have the experience with such type of income and therefore you must research on him or her before you seek help. The consequences of failing to report include:

• The issue may come back to haunt you
• Your tax return may be rejected
• The IRS may rectify your return and adjust the refund sending you a bill for what is due and
• You may face fines as well as other penalties.

There are however a few exclusion in such reporting depending on the situation in which the debt was cancelled. These exclusive situations include:

• You went on to file bankruptcy to discharge the debt unless it was a debt for business or investment
• If it is a student loan forgiven by any educational institution which is exempted from tax and you have worked for a specific period t time as a qualified employer
• If it was a mortgage on your primary residence that you may have lost in foreclosure, restructured mortgage or sold in a short sale and
• You are insolvent at the time the debt was cancelled.

However, according to the law, when you want to take insolvency exclusion or for forgiven mortgage you must file IRS Form 982 so that you do not face any tax penalty on it. Remember, state laws for cancelled debts may differ from federal tax law and therefore you must consult a tax professional for this matter.