What is Cancellation of Debt (COD)?
When someone’s debt is large compared to their income and they are under extreme financial hardship, it may be in the best interest of the borrower to negotiate a debt cancellation with their lender. That is where a 1099-C form comes into play.
What is a 1099-C?
A 1099-C is a tax form that the IRS requires lenders use to report “cancellation of indebtedness income.” This form must be filed in certain circumstances where more than $600 in debt is cancelled, or goes unpaid for a certain period of time. This is how you report your cancelled debt on your tax return documents for the year the cancellation took place.
Will a 1099-C Hurt my Credit Score?
If you have received a 1099-C , chances are the damage to your credit has already been done. Unpaid credit card debt, a foreclosure on your home, a vehicle repossession or other similar incidences where you did no pay a debt will have most likely been reported to your credit reports.
Are Lenders Supposed to Send 1099-C Forms?
When a debt is cancelled, your lender is supposed to send you a 1099-C. However, if you didn’t receive it, don’t assume you are in the clear. Whether or not you receive a 1099 document, count on the IRS having a copy.
How does the IRS Classify Cancelled Debt?
When your debt is cancelled the IRS sees the leftover amount as income you didn’t return. Why? Because you received a payment you didn’t return.
When you first borrow money, you don’t have to pay tax on the money you receive because you are bound by a contract to pay it back. Once that contract no longer exists, the money is yours to do with as you please. Since you essentially received income for free, the cancellation of your obligation to pay it back makes it taxable.
Are There Exceptions to Cancellation of Debt Income?
Yes, an example of this is student loans. Certain loans have provisions that allow your loan to be forgiven after a certain period of time.
The way you deal with your debt can affect the amount you pay in taxes. If you have questions or want to discuss your options, give us a call or email today.