It’s no secret that millions of Americans are in debt. If you borrow money from a lender and sign the dotted line on a legal document obliging you to pay it back, you have debt. The total amount of credit card debt alone is about $764 billion, while student loans have reached a total of $1.34 trillion. If you’re burdened under a pile of debt, whether it be from car loans, mortgages, credit cards, or student loans, there are many just like you trying to reach financial freedom. Thousands who face debt may find it difficult to make ends meet, but our tax professionals at Community Tax have worked with many to help ease their debt concerns. Debt among Americans is growing for several reasons. Unlike the generations before us, the cost of living is increasing at a staggering rate faster than the growth of the median income. Medical, housing, and education costs are just a few of the expenses that take a big bite out of our bank accounts. For many, it becomes difficult to make it through without relying on more credit, which leads them to consider a Cancellation of Debt in order to relieve their existing financial obligations. What is a Cancellation of Debt? Keep reading to learn more or use the jump links below to navigate to your question at hand.
- What is a Cancellation of Debt?
- Reporting Cancellation of Debt
- What is Form 1099-C, Cancellation of Debt?
- What should I do with a Form 1099-C, Cancellation of Debt?
- How does the IRS classify canceled debt?
- What if my debt is canceled by a private lender?
- Are there exceptions to the Cancellation of Debt income?
- What is excluded from gross income?
- Is there an exception for a mortgage?
- Are bankruptcy discharges taxable?
- What if I don’t agree with the information on the Form 1099-C, Cancellation of Debt?
- How Community Tax Can Help
What is a Cancellation of Debt?Also known as COD, a Cancellation of Debt is the result of a creditor discharging or forgiving debt for less than the full amount owed. The amount the debtor is no longer required to pay is considered “canceled” in the eyes of the law, but that doesn’t necessarily mean the once-owed money simply disappears from the record. For some people, their debt is so large compared to their income that they can’t pay it off without undergoing extreme financial hardship. In this case, it may be in the borrower’s interest to negotiate a debt cancellation with their lender—but this doesn’t come without a tax bill. There are consequences that can arise from a Cancellation of Debt, as well as reasons for why one might pursue this form of financial relief. Namely, if your lender agrees to your debt cancellation, then you will likely have to report the canceled debt amount in your income for tax purposes, depending on your circumstances.
Reporting Cancellation of DebtAccording to IRS.gov, if you have canceled, forgiven, or discharged debt for less than the amount you pay, the amount of the canceled debt must be reported as taxable income (unless you qualify for a special exception). This is because when you took out the private loan, you didn’t have to include the loan proceeds in your income since your responsibility was imposed on the lender. Most taxpayers report income to the IRS on their individual income tax returns using Form W-2 provided by their employers. However, the government relies on certain information returns—known as Form 1099s—to record taxable money given or paid to you by an entity other than your employer. There are different kinds of 1099s depending on what type of income or debt is being addressed for taxation:
- The 1099-B is for broker transactions and barter exchanges
- The 1099-DIV is for dividends
- The 1099-Sis for real estate transactions
- The 1099-G is for state and local tax refunds and unemployment benefits
- The 1099-INT is for interest
- The 1099-Ris for pensions and payouts from retirement accounts
- The 1099-MISC is for miscellaneous information