1099-C In The Mail? How To Avoid Taxes On Cancelled Debt
If it’s been a rough couple of years for you, you’re not alone. Maybe your income was cut, you lost your job, or you had large expenses like medical bills. You may have fallen behind on bills, fielded collection calls and managed to settle some of your debts for less than the full balance you owed. You’re hoping the worst is behind you.
But then, to add insult to injury, you’ve received a 1099-C Cancellation of Debt form in the mail listing the forgiven amount. Suddenly, you’ve got a potential tax nightmare.
According to the IRS, if a debt is cancelled, forgiven or discharged, you must include the cancelled amount in your gross income, and pay taxes on that “income,” unless you qualify for an exclusion or exception. Creditors who forgive $600 or more are required to file Form 1099-C with the IRS. Nearly 2.7 million of these forms were processed by the IRS in 2009 and that number is expected to increase for the 2010 tax year.
The potentially tricky part is figuring out whether you quality for an exclusion or exception. If you don’t get it right (or ignore it all together), you may pay more in taxes than you have to. But figuring out how much you must pay may be easier said than done.
In her 2009 report to Congress, the National Taxpayer Advocate Nina Olsen called upon Congress to “Simplify the ‘cancellation of debt’ minefield that many taxpayers who default on debts must navigate.”
Karla Dennis, Enrolled Agent and CEO of Cohesive Tax says her firm is “absolutely seeing an increase in (taxpayers with 1099-Cs). It’s almost every client who comes through the door. Taxpayers really are scared about it.”
“I would estimate 40 – 60% of the people (who receive a 1099-C or 1099-A) don’t owe this tax,” says William J. Purdy, III, an attorney with a Master’s degree in taxation who
practices in the Law Office of Simmons & Purdy in California. But he also warns that many taxpayers won’t know what to do to avoid paying.
(In a future post, I’ll discuss Form, 1099-A – Acquisition or Abandonment of Real Property, which is often sent when taxpayers let their homes go into foreclosure.)
First Things First
If you’ve received a 1099-C, don’t ignore it. “A copy of that 1099 has been mailed to the Internal Revenue Service,” warns Steven J. Elliott, CPA, MST, Tax Director for Schwartz and Company, LLC . “The IRS is looking to have that income included in the tax return, unless there is an exception or exclusion.”
Elliott goes on to caution that “Even if you don’t get a Form 1099-C from a creditor, the creditor may very well have submitted one to the IRS. If you haven’t listed the income on your tax return and the creditor has provided the information to the IRS, you could get a tax bill or worse, an audit notice. This could end up costing you more in IRS interest and penalties in the long run.”
If you are accustomed to doing your own taxes, this is one situation where it can really pay to get expert advice from a tax professional* who has experience with this particular issue. Together with your tax advisor, you will be trying to determine whether you can avoid or reduce the amount of cancelled debt on which you have to pay taxes due to one of the following exceptions or exclusions:
Cancelled Debt that Qualifies for Exclusion from Gross Income:
1. Cancellation of qualified principal residence indebtedness
2. Debt cancelled in a Title 11 bankruptcy case.
3. Debt cancelled due to insolvency
4. Cancellation of qualified farm indebtedness
5. Cancellation of qualified real property business indebtedness
How to Avoid Taxes on Cancelled Debt (cont.) »Source: www.businessinsider.com