What Does Cancelled Debt Mean for Your Taxes?

Many people think that once a debt has been cancelled (and please remember the difference between cancelled and charged-off, which means your debt has merely moved to a different entity) they are “off of the hook” financially as far as that debt goes. Unfortunately, that’s not true.

It’s becoming a more and more common practice among creditors to file a 1099-C form with the IRS when they announce a debt to be cancelled. So much so that last year alone, six million 1099-C forms were sent to the IRS by creditors. And yes, the question on your mind right now is probably something like “what is a 1099-C form and what does it mean when your creditor files it to the IRS?”

Well, the IRS considers cancelled debt additional income. Think of it like this: technically, the creditors are giving you the sum of money that is the cancelled debt, because you received it but never repaid it. So, the IRS considers it additional income, and taxes it accordingly. However, not all cancelled debt gets taxed – this is where the 1099-C form comes into play. It’s a way for the creditor to let the IRS know that this amount of debt has been cancelled, so that the IRS knows to tax it. And, as we mentioned previously, this is a practice that has increased in popularity among creditors in the last few years. If the 1099-C form isn’t filed, then the cancelled debt doesn’t get taxed.

If you have debt that will be, or has been, cancelled, you need to be aware that the odds are relatively high that you’ll have to pay taxes on it. If the creditor sends the 1099-C form to the IRS, you will also receive a copy. At that point it’s crucial not to ignore the notification, because doing so can get you in some real trouble with the IRS.

There aren’t a lot exceptions to the additional income practice, but there are a few. Cancelled debt from foreclosed houses, or student loan forgiveness through a qualifying job program don’t require you to pay taxes on the cancelled debts. But, in every other case the most viable option for avoiding the extra financial distress of taxes on your cancelled debt is to declare bankruptcy. If you declare bankruptcy, your cancelled debt will not be taxed, and, in general, you get the chance to start with a clean slate.

If you have any questions about this or anything else credit and debt related, please don’t hesitate to contact us. As a leading Philadelphia credit restoration company we can help you find the way out of your financial problems.