Form 1099-C for Cancellation of Debt

When debt is cancelled, such as by a credit card company or bank, that is not the end of the story. A canceled debt is actually considered income and, under the treasury regulations, must be claimed as taxable income. This is where form 1099-C comes into play.  

What Is Form 1099-C?

Form 1099-C is also called a Cancellation of Debt Income form. This form is generated when a debt is cancelled. It is used to inform the IRS of the cancelled debt, allowing them to tax you accordingly. If received, a form 1099-C should never be ignored, as doing so is tantamount to tax evasion. Ignoring it usually creates a tax assessment with additional penalties.  

Who Qualifies for Form 1099-C?

Unlike other tax forms, there is not a lot one must do to qualify for form 1099-C. In fact, anyone who has had a debt cancelled has received a form 1099-C.  The IRS receives a copy of the 1099-C that is mailed to you by the creditor.  

How Much Cancelled Debt Must Be Reported to the IRS?

Under United States tax law, cancelled debt is considered income, meaning it must be reported to the IRS, even if it is for a small amount. However, it should be noted that creditors are only required to report cancelled debts to the IRS if they are over $600. In these cases, the form 1099-C will be automatically generated and sent to you. If your cancelled debt is less than $600, then it is on you to alert the IRS of the cancelled debt.

Taxation on the Forgiveness of Debt

As mentioned above, cancelled debt is exactly the same as income when it comes to taxes. This means that it will be taxed at the same rate as any other income. For example, having a debt of $5000 will result in owing the same amount of taxes as you would if you earned an additional $5000 by working. Unfortunately, this can result in owing unexpected taxes which may be difficult to pay depending on your financial situation.

Bankruptcy and Form 1099-C

So, what implications does form 1099-C have on bankruptcy? Are you going to owe taxes on all debt that is canceled through bankruptcy? Fortunately, the answer is usually no. Any debt that is cancelled through title 11 bankruptcy, which includes both chapter 7 and chapter 13 bankruptcy, is not considered taxable income. You will not have to pay taxes on any debt cancelled through bankruptcy. Any form 1099-C forms you receive should have a box checked, showing that the debt was cancelled due to bankruptcy. In these cases, you will have to fill out and attach Form 982 to your federal tax return. This form informs the IRS that the cancelled debt is not to be included in your gross income on your tax return and that the debt is legally excluded from your income due to the filing of a bankruptcy.  

Mortgage Forgiveness Debt Relief Act

There have been times when forgiven debt that would usually count as income has been excluded. Such an example is the Mortgage Forgiveness Debt Relief Act of 2007. This act was passed in response to the 2007 housing market crash. The intention was to help homeowners who were facing foreclosure during the 2007 housing crisis.

Under the Mortgage Forgiveness Debt Relief Act, homeowners were able to exclude forgiven mortgage debt from their taxable income. This included debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure. The law only included debt forgiven in calendar years from 2007 to 2017. Up to $2 million of forgiven debT was eligible for this exclusion or $1 million if married and filing taxes separately. 

The Mortgage Forgiveness Debt Relief Act prevented thousands of homeowners from having to pay additional taxes they couldn’t afford. This allowed them to get back on their feet more quickly after a foreclosure and mitigated the negative effects of the housing market crash.

Can an Individual Issue a 1099-C to Another Individual?

Banks and other financial institutions are not the only ones who lend money. It is very common for private individuals to lend money to each other, and even for that debt to be forgiven. For example someone may lend a friend $2000 for car repairs and then, upon realizing the dire financial situation their friend is in, decide to forgive the debt. Form 1099-C is not applicable in these situations. Form 1099-C is only to be used by commercial lenders, including banks, credit unions, and federal institutions. It is not to be used when individuals forgive the debt owed to them by other individuals.