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If you got a 1099-C in the mail and thought, “Why is this happening?!” join the club — most Americans are frightened by tax forms. But the last thing you should do is ignore it. A copy of these forms are electronically sent to the tax man, and the tax man will slap you with penalties if you fail to report it. We tapped Kay Bell, the savvy blogger behind Don’t Mess With Taxes, for the low-down on this often confusing tax form.

What’s a 1099-C?

Simply put, a 1099-C is a form you receive from a lender with whom you negotiated payment on a debt. So, if, for example, you owed a credit card company $5,000 and worked out an agreement to pay only $3,000, the $2,000 you didn’t pay would be counted as phantom income. (Yes, that’s a thing.) Who knew haggling with a lender would come back to haunt you?

Why Is Cancelled Debt Considered Income? 

“It’s income because it’s money that you didn’t have to pay,” says Bell. “It doesn’t seem reasonable, but it’s the same sort of thing as winning a prize. The value of that prize is taxable.”

Now What Do I Do?

Like a W-2, you’ll need to report the 1099-C on line 21 of your 1040, i.e., the line where you report other income. This is where you report any income outside your wages or salary, says Bell, such as lottery winnings.

Can I Get Out of It? 

According to Bell, not really. But there are some exclusions and exemptions. Canceled debt that qualifies for exclusion from gross income includes:

  • Debt canceled in bankruptcy
  • Debt canceled due to insolvency
  • Cancellation of qualified farm indebtedness
  • Cancellation of qualified rental property business indebtedness

Canceled debt that qualifies for exemption from gross income includes:

  • Cancellation of certain qualified student loans
  • Canceled debt that, if paid by a cash-basis taxpayer, is otherwise deductible
  • A qualified purchase price reduction given by a seller
  • Amounts specifically excluded from income by law such as gifts or bequests

IRS Publication 4681 can get you up to speed on more of the details.

Will a 1099-C Hurt My Credit Score? 

That depends. While the event that triggered the 1099-C — think unpaid credit card debt, car repossession or a foreclosure — was definitely reported to the credit bureaus, the form itself wasn’t. So, basically, the damage is already done. (You can get a free credit report summary on Credit.com to see how that old debt is impacting you.)

However, a 1099-C can increase your tax liability and even turn a year in which you would have received a refund into a year in which you owe the IRS money. And if you can’t pay, a tax lien could be filed against you and that can definitely do some credit score damage.

More on Income Tax:

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