Debt Settlement: Cancellation of debt income, what's up with dat?
It's 1099 time and many of our clients are receiving statement 1099-C for cancellation of debt income. You may have received one from a bankruptcy or a debt settlement. What should you do with them? First off, don't panic. Merely receiving the 1099 does not mean you must pay taxes on the "income". Read on for more information.
Financial entities who make a settlement with a debtor for an amount less than the balance owed, are generally required to file 1099-C with the IRS if the amount is $600 or more. They report to the IRS that they "canceled" debt in an amount equal to what they wrote off on the deal.
While the income is definitely reportable, it may not be taxable depending on your personal situation. Generally, cancellation of debt income is taxable (don't panic just yet), there are exceptions to this rule, which apply to most of our clients. The exceptions are:
- Debts discharged in bankruptcy
- You are "insolvent" but haven't filed bankruptcy
- It is for qualified personal residence indebtedness
- Certain farm indebtedness
- Qualified business real property indebtedness
I won't go into the later 3 items, as most of our clients fall within the first two. Bankruptcy is easy to see and identify. You either filed or not. Determining whether you met the insolvency exception is a little bit trickier. First off: solvency means your total assets (stuff you own) exceeds your total liabilities (what you owe). A quick and easy test: if you were insolvent both immediately before and immediately after the debt was canceled, then none of the income will be taxed. If you were insolvent before but solvent afterward, income to the extent of the solvency will be taxable. If you were solvent before (and naturally afterward) the income will be taxable. Many people who are working at settling their debts for less than the balance owing are insolvent, but that's no guarantee. I strongly suggest you hire a qualified EA (enrolled agent) or CPA (Certified Public Accountant) to assist with your taxes if you have cancellation of debt income. Form 982 is the form to use. Like most of the tax laws, there's more to it than one could possibly explain in a blog, so professional help is definitely warranted. My blog is not meant to replace professional advice; it doesn't cover all aspects of the tax law. So, do yourself a favor and get good professional help.
This might throw you, but I recommend you include ALL of your cancellation of debt income on form 982. EVEN IF YOU DID NOT GET A 1099-C. One, because that is what the law requires, and secondly, the financial entity may well have issued a 1099-C, but did not have your current address. This happens more than you can imagine! So, while you did not get the form, the IRS sure did and they WILL be looking for it on your tax return. Save yourself the audit, okay?
I am happy for your feedback or any questions you may have. You may reach me at the office, 800-455-1592. Also, both Doug and I will be posting helpful tips and data on the blog, so please follow us. We are on facebook and linked in also.
Suzanne Eisenstark is a CPA licensed in Texas since 1982. She has worked for a "Big 8" accounting firm (if you know what that means, you're showing your age), founded and managed a CPA firm in Dallas/Ft. Worth for 20 years. She now works as an outsource CFO for two companies and works with clients of Crowder Law Center.
Crowder Law Center is a Los Angeles law firm providing debt relief services, including bankruptcy, Chapter 7, Chapter 11, Chapter 13, litigation, adersarial litigation, debt settlement, and banruptcy alternatives.