Published on: January 30, 2018 Last modified: October 21, 2020

When Cancelation of Debt Becomes Income

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    Michigan taxpayers heavily in debt often have only a limited number of options. If they fail to make a house payment, they can face foreclosure. On the other hand, if they negotiate with creditors to reduce the amount of debt they owe, they may then have to pay additional taxes. This is especially common with forgiveness of credit card debt.

    Lenders are required to issue a 1099-C concerning the forgiveness or cancellation of debt. The 1099-C will specifically list the amount of debt that will go unpaid. This amount in turn the taxpayer must report as income.

    The Specifics Concerning a 1099-C

    When a debt collector agrees to forgive $600 or more in debt from the original balance, they must then submit a 1099-C to the IRS. Those owing at least this amount of forgiven or canceled debt may receive a 1099-C and thus be required to report the forgiven debt as income on their tax forms. While this seems straightforward, most people struggling with debt are probably not thinking about tax issues when trying to make the debt goes away.

    There are six exceptions to having to pay taxes upon this forgiven debt, however. Such exceptions would include:

    • Cancelation of debt when the individual is insolvent
    • Bankruptcy discharge of debt
    • Forgiveness of student loans after a period when the individual was working
    • Forgiveness of interest that would otherwise be deductible
    • When the cancelled debt was a part of a gift
    • Business and farm exclusions listed under Form 982

    What Should You Do?

    As is to be expected, such exceptions contain a number of conditions. Determining whether such conditions apply to your circumstances can be difficult, and it’s often necessary to have an experienced tax attorney provide guidance regarding such matters. Tax rules can prove extraordinarily complex and often obscure.

    You have the right to take advantage of the laws in making certain you owe as little in taxes as possible. Yet providing inaccurate information to the IRS or not supplying required information at all can only lead to problems. The IRS can harshly penalize taxpayers in a number of ways.

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