Debt Can Go Away but Taxes Won’t

Debt Can Go Away but Taxes Won’t

When you don’t pay your bills, somewhere down the line it has to end in one of several conclusions.  After wrangling with your credit card company or your mortgage lender, a solution like a payment plan can be worked out. But if  no solution is worked out, or you abandon your home, or your car gets repossessed, there is an even more final conclusion: cancellation of debt. When your debt is cancelled, the IRS gets involved and a 1099 is issued.

The IRS document that’s issued is actually called a 1099C, for Cancellation of debt.  Your lender provides the information to the IRS and you will get the 1099 in the mail.  This must be used when you do your federal income taxes.  Cancellation of debt is treated as income.  So, if you walked away from a $100,000 mortgage, your taxes that year will have to include an additional $100,000 income and you must pay taxes on it.

IRS Form 982

Sometimes you may not have to pay taxes on some or all of that cancelled debt.  Use IRS form 982 to explain to the IRS why you don’t have to pay taxes on that sudden extra income.  Fill out the form and you may be able to exclude some of the 1099-C amount from your income.  Get a hold of IRS Publication 4681, which is available online here.  It’s called Canceled Debts,Foreclosures, Repossessions, and Abandonments.  Here you can learn what types of debt will be included as income on your taxes.  It’s a little involved, so some people like to go to a friend who knows a lot about taxes or finances to get help.

For example, sometimes Student Loans are cancelled but you don’t have to pay income taxes on the cancelled debt.

Another exemption is due to a law recently passed by Congress.  If your home was foreclosed, you may not have to report the mortgage amount as income.

If you don’t file IRS form 982, the IRS will assume that you must pay income tax on all the cancelled debt, according to the 1099C they receive from your lender.  It’s up to you to fill out the form and claim an exclusion, if you have any.