I received a 1099-C for forgiven debt. Do I have to pay more tax?
If you or a debt management company has successfully negotiated a settlement of your credit card debt, and the amount is over $600, you may receive a 1099-C.
It basically states that unless the amount forgiven (IRS terminology for settlement) is exempt, then it has to be included as additional income subject to normal taxation.
So, how do you determine if the forgiven amount is exempt?
According to IRS Form 4681, there are several exemptions to including forgiven amounts back into taxable income.
For the purpose of this article, let's focus on the settlement or forgiveness of credit card or unsecured debt.
On page 4 of IRS Form 4681, there is an explanation of "INSOLVENCY". As usual, the government has a hard time explaining the rules (I think they do it on purpose!), but basically the rule states:
If at the time of the settlement or forgiveness you were INSOLVENT, then the amount of the forgiveness IS NOT INCLUDED as additional taxable income.
How do you determine if you were insolvent?
At the time of the settlement, you need to show that your liabilities were only equal to or greater than your assets.
You need to complete a basic budget showing all of your income, outgo, and assets:
- Equity in your home
- Net value of your automobile(s), boat, etc.
- Net value of jewelery, stocks, bonds, etc.
- Savings or investment accounts
- Net furniture value, coin collections, etc.
For most people who have negotiated a settlement of their credit card or cards, they usually do not have any real assets and therefore the amount forgiven is not included as additional taxable income.
You will need to complete IRS Form 982. You will check a couple of boxes and sign, and along with the Budget Worksheet, turn in with the 1099-C and your normal tax return.
Don't be surprised if your tax preparer or accountant is not really up on this procedure! You might want to download IRS 4681 for their review.
We have helped dozens of tax preparers and accountants deal with the 1099-C issue and would be glad to assist.
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