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Subscribe to RSSCreditors are often willing to negotiate a significant discount to settle a debt they know the customer can’t pay in full. Millions of Americans buried in consumer debt took advantage of such a settlement offer last year.
Now it’s time to pay taxes on the part of the debt that was forgiven.
“If you had any debt that was forgiven and the amount you saved was more than $600, the IRS considers that taxable income,” said Bill Hardekopf, CEO of Lowcards.com. “You need to claim that on your tax return.”
Let’s say you owed the credit card company $15,000 and they let you settle the account for only $10,000. The $5,000 they forgave is taxable. If you’re in the 15 percent tax bracket, you’d owe $750. Clearly, that’s easier on your budget than the $5,000 you owed, but it could come as quite a shock if you didn’t know about it.
In general, any creditor or debt collector who agrees to reduce the balance you owe by $600 or more is required to report that to the IRS. They file a form 1099-C and send you a copy.
“People tend to miss this because they didn’t see any cash from the debt settlement and therefore they just assume this is not income,” explained Certified Public Accountant Carmen Aguiar, CEO of The Aguiar Group in Bellevue, Wash. “This puts you at risk of being audited or hit with penalties and interest.”
Credit counselors tell me some people are surprised to get the 1099-C form in the mail.
“A lot of these creditors and debt settlement companies don’t disclose when the settlement is negotiated that the consumer can expect this tax liability later on,” said Bruce McClary, director of media relations with Clearpoint Credit Counseling Solutions.
And there’s no law that requires them to provide this information. So when a letter arrives from a past credit or collection agency, it’s easy to assume that it’s trash and throw it away.
“The way they find out that they owe taxes on the settlement is when they hear from the IRS asking why they didn’t pay a tax liability reported by their creditor,” McClary said.
The IRS expects to get 6.5 million 1099-C debt forgiveness forms this tax season. Tax preparers say it’s important to make sure the information is correct.
“They are not always accurate,” Aguiar told me. “They may show the entire debt, not just the amount that was forgiven.”
The 1099-C is a complicated form. If you get one and don’t understand how to read it, contact a tax professional. If the information is wrong, you need to contact the company and ask that a corrected 1099-C be filed.
“You have a right to dispute the 1099-C if you believe the information is incorrect and you have documentation of that,” McClary advised.
Some types of forgiven debt are exempt from federal taxes. According to CreditCards.com these include: debts discharged in bankruptcy, mortgage debt forgiven in foreclosure, debts cancelled when you are insolvent and some student loan debt. (Read: 6 Exceptions to Paying Tax on Forgiven Debt)
IRS Publication 4681: Canceled Debts, Foreclosures, Repossessions, and Abandonments
Herb Weisbaum is The ConsumerMan. Follow him on Facebook and Twitter or visit The ConsumerMan website.
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Of course it should be considered income. If you buy something or take money out on a credit card then don't pay it back you will have to at least pay taxes on the money you were forgiven. That should help get back at these dead beats.
First, does anyone know if this is also true of commercial debt that a business expunges? If it's not, it should be. What's good for the goose...
Second:
Since medical expenses are the primary cause of personal bankruptcy in this country, I find it a little harsh to call those declaring bankruptcy "dead beats."
What if that $25k in credit card debt wasn't on a new stereo, but rather on a chemotherapy regimen? Are they still "dead beats?"
Who puts medical expenses on a credit card? I never have and never will. You can setup payment plans with the provider instead of adding to your credit card debt. If the medical providers, pharmaceutical companies, and insurance companies weren't so greedy, and in this together, it might not be so expensive to get the healthcare you need. Unfortunately Obamacare addresses none of that and medical costs will continue to rise at astronomical rates.
To answer your question, debt forgiveness is taxable income for corporations as well as individuals. Yes.
If you took care of yourself, you wouldn't have medical debt! Yes, people who go into bankruptcy because of medical debt ARE dead beats.
good to know, glad we're all on the same foot.
/palmface
tell that to a self-employed, healthy, responsible women who develops breast cancer and can't pay out of pocket after the private insurance she was barely able to afford BEFORE she got sick from Chemo and couldn't work anymore drops her from the rolls.
I'm tempted to call you an idiot, but I don't wanna bring out the ban hammers...
ImoenOfTelengard, such insight. So, someone who develops cancer, endures drawn out expensive painful procedures not covered by insurance is a) guilty of not taking care of themselves; and b) a dead beat. Got news for you. Tell me how a person on a fixed income would pay off $500,000 in medical costs? I'm guessing from what you said they should have refused treatment and had the decency to just die. Really, what if that was your mom? Would you deny treatment over money. I sure hope not. I also wonder whose wisdom it was that determined a person who is bankrupt can afford to pay taxes on money the IRS has identified as income. If you are broke enough to file for bankruptcy you are too broke to pay trumped up taxes.
paduki, on the bright side, anyone dealing with serious issues such as a life threatening illness or who have someonne close to them dealing with one really has no time to care about responses from mean unhappy losers on the internet acting self righteoous(how pathetic).
have a nice day, including alll you little deadbeats:)
I dont agree with that, and I have found that MOST Collects DO NOT SEND that 1099-C. And you may think that a person that negoicates there debit down are deadbeats, I just hope you never end up with 75000 medical bill that your insurance doesn't pay for and lets see you survive. Or you and the wife BOTH lose their jobs at no fault of your own, then you live on unemployment... and you guess the rest.
This is not fair, this is a population of people that are making efforts to pay their debts by making a settlement with the lender and it is more than likely due to having fallen on hard times. They are not walking away from their obligations or defaulting and then to get hit with this tax is just adding more financial burden.
When it comes to taxes, nothing is really fair. It's about getting money to feed the machine and keep itself alive.
I would be fine with forgiven debt as taxation as long as tangeable assets have been acquired with the money, except the IRS does not allow full deduction of debt LOSS in other forms of investment and debt except for the regular 3K a year. If you make money one year as income you should get taxed. If you lose money one year you should be able to deduct that loss. Same as with homes: No one complained when the price of houses were going up and they were being sold for more than the fed exemption and were paying taxes. Now that they are going down and people are selling for losses, people should be able to deduct the capital losses on a house, but they cannot. It is everyone's envy to run slanted racket like this.
I can agree that debt forgiveness should not be taxed in some cases, but I'm not ok in cases like mortgages where someone bought a home they couldn't afford in hopes of flipping it in a couple years - and there are millions out there like that today.
Based on my experience, the vast majority of people that have debt problems are in trouble due to their actions. Having society cover their debts just teaches them to continue making bad financial decisions because there are no negative consequences.
About twelve years ago i got stuck with this and ended up with an unplanned $800 tax liability.
Quite frankly, i think it is fair after i thought about it, the company that allowed you to negotiate down that loss also claimed that loss of income on their taxes, otherwise they would have to pay that tax on income they did not receive. I, on the otherhand, presumably got the benefit of that service or product without having to pay for it, which is dollarwise valued equivalent to the amount of mony not paid for that item. Thus the value was transferred to you from the company that you neogitated with.
Please note that I am assuming that the item and charges you paid or negotiated over were fair dollar amounts. If it was illegal or unfair you should manage that with the creditor before you negotiate down or you will be unfairly taxed.
I myself had debt forgiven on a credit card i couldn't pay off after losing my job. It was a horrible experience all around and when i found out about the tax thing I felt like I got kicked in the head after being struck by a car, but I understand why I was taxed and i was able to work out a deal with the IRS where i could pay it off over time without penalty or fees, which i thought was a fair deal.
Typically when the balance is negotiated, the creditor is eliminating intrest, late payment fees and service charges. A lot of the debt they are willing to let go is not related to the actual cost of the items purchased, plus, as a business owner, all items purchased have to be "depreciated" on tax returns, therefore the items purchased MUST have be devaluated and that balance could then be considered "income". But, since the intrest, late charges and service fees are the only thing being discounted, the purchased items are still on the books and being paid for, thus not income! If this were true for all things the IRS would be taxing you on assumed earned income before you even got it!
They already do. In a manufacturing business where a deposit is taken on a product and one is forced to pay quarterly, based on last years income; the IRS in essence is requiring you to pay on monies not yet generated.
This happened to my son a few years ago due to using his credit card more than he should have. He started out with one from college, even though we told him not to get one. Fast forward a few years later, we, his parents, get the phone call that he's getting hounded by those phone calls constantly, wanting payment. We advanced him the money and he had the money he owed us deducted automatically from his paycheck and sent to us. He finally negotiated a sum he could pay back and the rest was "forgiven". Hah! Yes, he did have to declare the forgiven amount as income, but it was a small price to pay to get out from under his stupidity. He has since cut up the card, and if he can't pay cash, he doesn't buy, that simple. And, he paid us back in full with interest.
Stupid law. Pending on how much the debtor owes, it's probably better to just file bankruptcy and pay nothing. Sucks for the creditor but hey. They can take it up with the IRS for having such a dumb law.
not to put to fine a point on this but the IRS doesnt make any law they are just another enforcer of laws put in place by congress. and congress gets away with this crap because we keep re-electing these 535 nitwits over and over again
And the IRS goes after these folks that no doubt were struggling, while unable to control 98,000 federal, postal and congressional employees that owe 1.03 billion.
personal story, defaulted on a va loan (too long a story to add here) and after the default the house was sold at a much lower price that the original note i/e note was 50,000 and default sale was 35,000 not long after the IRS and i had several conversations to no real point other than i owed taxes on the 15,000 difference. this will probably be happeneing all over the country soon, if not already happening, from all the defaults that happened in the crash of 08
"The 1099-C is a complicated form." Really? Has the author of this article ever seen one? It couldn't be much simpler: the amount forgiven, the date, and a description of the debt. That's about it.
The article also failed to note that IRS rules state that if you can show you were financially insolvent (had more liabilities than assets) at the time the debt was forgiven, you can avoid declaring this amount as income. There are a myriad of exceptions going either way, and it requires a bit of research if you find yourself in this position.
The Devil is in the details. How does one prove to the IRS that they are financially insolvent? Other than large amounts of unpaid bills. And if you ARE, they would probably just tell you to file BK. Lose/lose for all.
It used to be "if you have it, we'll tax it."
Now it's "if you don't have it we'll tax that too."
In fact this fiscally incompetent and irresponsible administration believes that if you even thought about making a profit, you should pay taxes on that thought!
Unless, of course, you contribute to Progressive campaigns. In that case, like Jeffery Immelt you aren't even required to pay taxes on actual profits!
“….And in the end,
The tax you’ll pay,
Is equal to the crap you’ll take….”
(With apologies to John, Paul, George and Ringo)
This law has been around since 1934. Not exactly "new" news.