Smart TaxesSmart Taxes

Yikes! I owe taxes on canceled debt?

Maybe. Don't panic if you get a 1099-C or 1099-A for forgiven debt. You may owe tax, but you may qualify for an exception and not have to pay.

By MSN Money Partner Feb 3, 2012 1:32PM

This post is by Gerri Detweiler at Credit.com.

 

Taxpayers who have received 1099-C or 1099-A forms for debts that were forgiven, never paid back or wiped out in bankruptcy are freaking out and asking a lot of questions. The main theme of these questions is "Do I have to pay taxes on the amount on the 1099-C (or 1099-A)?"-- usually followed by "HELP!!?"

 

My first piece of advice: Take a deep breath. You may not have to pay taxes on the income listed on the 1099-C or 1099-A.

 

At the same time, doing nothing is not an option. If you got a 1099-C or 1099-A, so did the Internal Revenue Service. That means you must explain to the IRS why that amount should not be included in your income. If you don’t, the IRS will assume the money counts toward your income, and you may get either a smaller tax refund than you expected or, worse, a bill from the IRS.

 

How can you avoid including that amount in your taxable income? By showing that you qualify for an exclusion or exception. You may be able to simply fill out Form 982 (.pdf file), claim an exclusion or exception, and be done with it. Sometimes it’s more complicated than that, and you need to work with a tax professional.

 

Q. I included my automobile with my bankruptcy in 2010; it was a Chapter 7. However, I received a 1099 for the car that I included in the bankruptcy. What do I do now? Must I pay the taxes on this large amount even though it was included in my bankruptcy? Post continues below

A. Debt that was discharged in bankruptcy can be excluded from your taxable income. Take a look at Form 982. At the top of the form you’ll see box 1a "Discharge of indebtedness in a title 11 case" (don’t be confused by the reference to title 11 -- that’s just the part of the U.S. tax code that covers bankruptcy). You can check that box. On Line 2, you’ll put the amount that was discharged in your bankruptcy for that debt and any others that were reported on a 1099-C. That amount will be excluded from your income.

 

Q. My student loans were discharged. I am on Social Security. Do I have to file the 1099-C I received for $62,000? My student loans were discharged due to total disability and I don’t file taxes because Social Security is nontaxable.

 

A. Keep in mind you don’t file the 1099-C; the lender does. A copy has already been sent to the IRS. So you must now demonstrate to the IRS that part or all of that "income' is not taxable. How do you do that? By figuring out whether you qualify for an exclusion or an exception and, if you do, filing Form 982.

 

You mention that your student loans were "discharged." Do you mean discharged in bankruptcy? Or do you mean they were cancelled because of your total disability? If they were discharged in bankruptcy, read the previous question and answer for more information on how to claim the exclusion for bankruptcy debts.

 

If they were cancelled, it’s not quite as simple. According to the IRS, "Generally, if you are responsible for making loan payments, and the loan is cancelled (forgiven), you must include the amount that was forgiven in your gross income for tax purposes."

 

There is an exception for student loans that were used to attend a qualified educational institution and were cancelled because you worked for a certain period of time in certain professions. (An example would be a doctor who works in a qualified low-income area.) I didn’t find any reference to an exception or exclusion for student loan debt that was cancelled due to disability.

 

However, you may qualify to have part or all of the $62,000 excluded from your income if you are considered by the IRS to be insolvent. Review Form 982 and the instructions to see if you feel comfortable filling it out yourself. If not, your disability may qualify you for free or low-cost tax help through the Volunteer Income Tax Assistance Program.

 

More from Credit.com and MSN Money:

VIDEO ON MSN MONEY

4Comments
Feb 13, 2012 5:37PM
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Fair share to the IRS is everything you have plus 10%.
Feb 16, 2012 9:26PM
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People just don't understand what they are signing up for when they go into debt or continuously carry heavy debtloads.  They see the shiny new object of their desire, little or no down payment and a signature - what harm could come of that? There isn't a salesperson or institution alive or in existence that would willingly risk a juicy commission - warnings, if any, are contained in font 6 or smaller text - well disguised in legalese.  When that 1099-C comes calling it is just the final punctuation on a sad sad story. Included in income or excluded from income, either way, little comfort. Period.

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Forms 1099 A and 1099 C's are financially irresponsible people living beyond their means. Pay your debts................
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