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Tax season is upon us once again. Seems it comes earlier every year. If you’ve scheduled to sit down with your tax expert and have had any debts charged off in the prior year, be sure to mention this. A creditor reserves the right to report the loss of income from your unpaid debt — therefore making it income for you. If you borrowed any money over $600.00 and did not pay it back then the IRS counts that as income for you.
The creditor will usually claim the loss on their taxes to the IRS so they get a break on the unpaid debt. After All, they did lose money, and if you didnt pay it back, then that’s income for you. Your tax professional can guide you in the best way to handle the situation whether the debt was charged off or if you settled a full debt for less.
See this article for more information about cancelled debts & the 1099-C.
Here’s today’s financial links.
If your debt has been written off by a creditor then you may receive a 1099-c from the source. You must claims this amount as income on your taxes because you never paid it back- thus making it income. However if you “settle” this debt as “paid in full” with the creditor make sure you ask that they agree to the settled in full arrangement and not send the remainder as a loss to the IRS.
If the creditor willingly accepts “less than” as “full payment” then make sure they agree not to report remainder. The creditor can refuse but usually does not. See exceptions below for more information on excluded debts.
Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.
If the debt is a nonbusiness debt, report the canceled amount on line 21 of Form 1040. If it is a business debt, report the amount on Schedule C or Schedule C-EZ (Form 1040) (or on Schedule F, Profit or Loss From Farming (Form 1040), if you are a farmer).
Form 1099-C. If a federal government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.
Interest included in canceled debt. If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest will also be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible if you paid it. See Deductible debt, under Exceptions, later.
If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from box 2 of Form 1099-C. If the interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the amount shown in box 2 less the interest amount shown in box 3).
Discounted mortgage loan. If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount is canceled debt. You must include the canceled amount in your income.
Stockholder debt. If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is dividend income to you.
If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not realize income. This is because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal that you canceled.
Exceptions
There are several exceptions to the inclusion of canceled debt in income. These are explained next.
Nonrecourse debt. If you are not personally liable for the debt (nonrecourse debt), different rules apply. You may have a gain or loss if a nonrecourse debt is canceled or forgiven in conjunction with the foreclosure or repossession of property to which the debt attaches. See Publication 544 for more information.
Student loans. Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if you work for a certain period of time in certain professions for any of a broad class of employers. You do not have income if your student loan is canceled after you agreed to this provision and then performed the services required. To qualify, the loan must have been made by:
The federal government, a state or local government, or an instrumentality, agency, or subdivision thereof,
A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law, or
An educational institution:
Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
As part of a program of the institution designed to encourage students to serve in occupations or areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization.
Section 501(c)(3) organizations are defined in Publication 525.
A loan to refinance a qualified student loan will also qualify if it was made by an educational institution or a tax-exempt 501(a) organization under its program designed as described in (3)(b) above.
Deductible debt. You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception applies only if you use the cash method of accounting. For more information, see chapter 5 of Publication 334, Tax Guide for Small Business.
Price reduced after purchase. Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from the reduction. The reduction of the debt is treated as a purchase price adjustment and reduces your basis in the property.
Excluded debt. Do not include a canceled debt in your gross income in the following situations.
The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
The debt is canceled when you are insolvent. However, you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent. See Publication 908.
The debt is qualified farm debt and is canceled by a qualified person. See chapter 4 of Publication 225, Farmer’s Tax Guide.
The debt is qualified real property business debt. See chapter 5 of Publication 334.
Read the full text of the IRS statute: http://www.fourmilab.ch/ustax/www/t26-A-1-B-III-108.html
We hear this every tax season, people becoming so anxious about settling their debts but then being reamed by the IRS because that debt becomes taxable. We’ve written about this issue many times but it seems to arise again and again, especially at tax time.
Today we are featuring the full explanation of the 1099-c taxable income issue by expert debt settlement coach Charles Phelan of ZipDebt.com. He offers up a complete explanation of how the 1099-c issue can affect you when settling your debts and puts to rest those mis truths.
With collection agencies and debt sales reps getting more desperate to collect dollars during this credit crisis, they are telling many mis truths to consumers in an attempt to get payment. Only a true debt settlement expert will tell you the facts without an agenda.
Here is the guest post by Charles Phelan, an expert debt settlement coach and author of the ZipDebt system. You can visit his site to get a copy of his free debt settlement ebook and learn more about debt settlement done by the consumer, for the consumer.
Charles wrote about this issue on the ZipDebt blog which is very valuable to subscribe to if you’re interested in debt settlement and the industry. The original post can be found here. If you are interested in debt settlement but do not want to approach the issue alone, Hoffman, Brinker Roberts offers a full service that is fair and effective.
1099-c Taxable Income Issue
Two different consumers have informed me that a “debt consultant” (i.e., sales rep) at a settlement company made a specific claim about the 1099-C taxable income issue. The pitch is that if the client handles the negotiation themselves, they will be issued 1099-Cs by the original creditors and the forgiven balances will be fully taxable. Naturally, they also claim that if their company is contracted to handle the negotiations, they have some special method for getting around the 1099-C issue.
So we have two lies in one sales claim. That takes real creativity (or desperation). The first lie is that the forgiven balance is fully taxable when you get a 1099-C. That is false for the majority of debt settlement clients, due to the “insolvency” exemption. If you have a negative net worth, the IRS permits you to exclude the 1099-C amounts from income up to the amount by which you are negative. Therefore most debt settlement clients don’t have to pay taxes on the 1099-C amounts.
The second falsehood is the claim that a settlement company has some method of avoiding the issuance of the 1099-C in the first place. Nonsense! This is a blatant lie, period.
I’m not sure what magic-bullet technique these guys are claiming to have for eliminating the 1099-C factor. One possibility is a truly stupid tactic where you dispute the forgiven balance – the exact opposite of what you want to achieve through the settlement process.
Anyway, leaving aside idiotic tactics that will only backfire, it simply DOES NOT MATTER whether you settle the debt before or after charge-off. Either way, the creditor is REQUIRED BY LAW to issue a 1099-C for any forgiven amount of $600 or greater. Purposely waiting until after charge-off, the way one rep phrased the claim, does not create a path for avoiding the 1099-C. And if you were to follow this wonderful “advice,” it would also cost you some of the best potential settlements. (Some of the best deals available happen before the charge-off deadline via negotiation with the original creditors.)
What’s going on here is that it’s getting tougher and tougher for these settlement company sales reps to “close the deal.” Their huge fees are a tough sell, and smart consumers do their homework before signing a contract. Many of them find my website, realize that all is not as they were told, and start thinking about taking charge of the project with help from ZipDebt. The sales rep finds out they lost another big commission, and they start thinking of ways to convince people they should not handle their own settlement program. Hence the new “angle” on the tax issue.
Then again, now that I think of it, there may be some truth to their claim. Since many of their clients will either be forced into bankruptcy or get sued into paying back 100% of the debt anyway, then I suppose they can make the case that there will be no 1099-C forms issued. No settlements = no forgiven debt = no 1099-C .
