Do I Have to Pay Taxes on Cancellation of Debt?

Owing money to the IRS can be worrying, but what happens when you find out that your debt has been partially or fully forgiven? You’re in the clear, right?

Unfortunately, the IRS does not make it that easy. Even if your debt is forgiven, the IRS still defines it as a source of income, meaning that it must get reported for the following tax year.

This can be frustrating, but the good news is there are solutions available to you.

Settling Tax Debt with the IRS

No one wants to have to choose between putting food on the table for their family or paying back the IRS, but sometimes that exact situation can seem unavoidable. Thankfully, the IRS has implemented a few different measures that can either assist taxpayers with paying taxes owed in monthly installments or have part or all of their debt forgiven.

While getting all (or some) of your tax debt forgiven is great for many taxpayers with insufficient funds, debt forgiveness can add financial distress in other ways.

Form 1099-C: Cancellation of Debt

If you receive one of these notifications in the mail from your lender, then you have to report the forgiven tax debt as “income” on next year’s tax return. Form 1099-C refers to the actual form you use to report the debt-related income. Most of the time, there is little you can do to avoid a Form 1099-C, but there are always exceptions to the rule.

The reason forgiven tax debt is considered income is because the IRS views it as a benefit. You are receiving money for taxes owed you cannot afford. Once the tax debt is finally settled, the IRS considers that the money was given to you and thus, you must pay the consequences of owing Uncle Sam.

Examples of Why You Might Receive a Form 1099-C

According to the IRS, the vast majority of debt that is owed and then canceled, forgiven, or discharged translates to “taxable income.” Once you receive a Form 1099-C, the lender that forgave the debt will explain what you must now report to the IRS.

Common examples include:

  • Abandonment of property
  • Foreclosure
  • Modification of a loan on your principal release
  • Repossession
  • Return of property to a lender

Tax Help with the Mortgage Forgiveness Debt Relief Act

In response to the real estate market collapse of 2007, Congress passed legislation known as the Mortgage Forgiveness Debt Relief Act. It is designed to provide relief to people who are dealing with large chunks of tax debt.

The provisions explain:

  • The opportunity to exclude up to $1 million in forgiven mortgage debt for single filers, married filing separately, and head of household
  • The ability to exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly

Tax Help with Bankruptcy and Insolvency

If your tax difficulties have more to do with bankruptcy or insolvency, it is still possible to avoid taxation on forgiveness debt. Debt that was discharged in a Title 11 bankruptcy such as Chapter 7 or Chapter 13 is not considered income you must report to the IRS. Similar rules also apply for insolvency.

Additionally, debt that was the result of a qualified real property business or farm indebtedness is eligible.

Tax Help From Levy & Associates

Some people consider it unfair that the IRS will help forgive some of their tax debt only to punish them later on, but you have options.Levy & Associates has worked in the industry for more than two decades and can help represent your case. Contact 800-TAX-LEVY, or go to www.www.levytaxhelp.com for a free initial consultation.

Contact Levy & Associates for Dependable Tax Audit Services

Levy & Associates is available for free initial consultations. We’re happy to answer any questions you have about the audit process or address any concerns about your specific situation.

There’s never a good time to be audited, and the time-consuming process will take away from your business or family if you try to face it alone. Let us handle and coordinate communication, so you can return to your daily life.