More so than ever before it seems creditors are writing off debt and sending a 1099-C to the debtors, but there often becomes a problem when you consider bankruptcy and debt cancellation.
The Personal Bankruptcy Story
This excerpt of a personal bankruptcy story was shared online at a bankruptcy forum website on February 2, 2012: “I received my first 1099-C debt cancellation today…The debt had the amount of $6000…I am insolvent in that my net worth is several thousand dollars in the negative. [The original debt was a] $2000 debt that the credit card company sued me for over 5 years ago. My wages were garnished to pay this off, [and the company] sent me a $1000 check for overpayment…[before their] lawyers filed a satisfaction of judgment.”
Tax Implications of Receiving a 1099-C
The man giving the personal bankruptcy story was concerned about IRS tax implications over receiving a 1099-C. In the IRS instructions for a 1099-C, the IRS suggests you received the form because a lender has “discharged (canceled or forgiven) a debt you owed, or because an identifiable event has occurred that either is or is deemed to be a debt cancellation of $600 or more. If a creditor has discharged a debt you owed, you are required to include the discharged amount in your income, even if it is less than $600, on the “Other income” line of your Form 1040.”
Exceptions to the IRS Rule
There are exceptions to the IRS rule for reporting a 1099-C, and two of those exceptions are when a debtor has filed a bankruptcy or insolvency has occurred.
IRS publication 4681 covers the details for any identifiable event that has occurred.
The 4681 publication is entitled Canceled Debts, Foreclosures, Repossessions, and Abandonments. Under Chapter 1 of the publication, you can find Canceled Debts Exclusions listed on page 4. These instructions tell you how the IRS handles the exclusions under the IRS laws. The first exclusion listed is for bankruptcy, and
the second exclusion listed is for insolvency.
Debt discharged in a Title 11 bankruptcy case is not included in income. If the tax burden has been discharged, all you need to do is file an IRS form 982 with your federal tax return and check box 1a. Then, follow the directions.
You do not have to include debt cancellation in income to the extent you were insolvent immediately before cancellation. The IRS defines insolvency as the total of all your liabilities when it is more than the fair market value of all your assets.
Assets includes the value of everything you own including assets used for collateral, any exempt assets beyond the reach of creditors under the law, and any interest in a pension plan or retirement account. Liabilities include any recourse debts and certain non-recourse debts.
Help for Debt Cancellation and Bankruptcy
If you end up getting a 1099-C from a creditor, you most likely will need the help of a good tax accountant and/or lawyer. If you are anticipating filing bankruptcy, you will most likely need the help of a bankruptcy attorney.
- Tax Consequences of Debt Settlement or Canceled Debt (backtaxeshelp.com)
- Discharge of Debt in Bankruptcy? (betterbankruptcy.com)
- Can Filing Bankruptcy Settle an IRS Debt and Allow You to Start Over? (betterbankruptcy.com)
- Collections, Charged Off Debt, and Bankruptcy (betterbankruptcy.com)
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