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Some canceled debts are treated like income by the IRS. If you receive a 1099-C form, you’ll need to pay taxes on your forgiven debts.
Getting a reprieve from debt you owe can be freeing and relieving. But did you know that some forgiven debts are treated like income by the IRS? That means you might end up owing taxes on the canceled amount. If you had debt forgiven last year, you may receive a 1099-C cancellation of debt tax form in the mail soon. Find out more about the 1099-C form and how it could impact your tax liability.
What Does Canceled Debt Mean?
What Is a 1099-C?
Can a Creditor Collect after Issuing a 1099-C?
How Does Cancellation of Debt Affect Taxes?
Debt is considered canceled when it’s forgiven or discharged even though you didn’t pay it back as agreed. Here are a few examples of times when a debt is considered canceled.
Not all debts that are canceled require a 1099-C. They also don’t all impact your taxes. If you had any debts canceled or expect to receive a 1099-C, you may want to work with a professional tax service to file your 2020 taxes.
A 1099-C is a form used to report various types of income. It’s one of several 1099 forms that are used to report income that isn’t reported on W-2 forms. You might get 1099 forms if you have rent, royalty, or contract income, for example. Typically, the rule for 1099 forms is that if someone pays you $600 or more within a year, they must report it on a 1099—and you need to report it on your taxes.
The 1099-C form is specifically used to report income related to cancellation of debt. The IRS considers forgiven debt as income because you received a benefit without paying for it. If you borrowed $10,000 and only paid back $4,000, for example, then at some point you ended up with an “income” of $6,000.
According to the IRS, 1099-C cancellation of debt forms are used in the following situations:
The IRS notes that creditors do not need to issue a 1099-C cancellation of debt in some cases:
A creditor cannot continue to collect after it issues a 1099-C. When it issues a 1099-C, it’s stating that it considers the debt canceled or forgiven. You no longer owe the debt, which is why the IRS may now consider it income.
It’s important to note that just because you don’t owe the debt doesn’t mean your credit won’t still be impacted by it. Canceled accounts may still show up on your credit report—along with notes about any payments that you missed before that point—for up to 7.5 years. Not only are canceled debts a hit to your credit score, they can cause future lenders to question whether you’re someone who makes payments on debts as agreed.
In many cases, canceled debt may add to your taxable income. This can increase how much you owe the IRS or eat into your expected tax refund. Here’s an example:
Not all canceled debt works against you when it comes to tax burdens, though. The IRS provides a list of exceptions of 1099-C canceled debt that isn’t added to income. That includes:
As you can see, whether or not a canceled debt is counted as income for federal tax purposes can be a complex topic. The bottom line is that discharged debt may come back to burden you in the form of additional income on your tax return, so it’s important to be aware of this possibility.
If you’re working on your taxes and have received a 1099-C form, consider consulting with a tax professional or using tax software. Free tax filing services may not include all the right options for filing with this type of income, especially if you don’t have a deep understanding of the rules. Software walks you through completing the proper tax return forms by asking you questions and ensuring you’re including all the right forms and income.