If you settle a debt for a certain amount of money, the amount you don’t have to pay is “forgiven.” Using a really simple example, if you have a $10,000 debt, and you settle it for $5,000, the creditor has forgiven the remaining $5,000.
Creditors are known to file IRS Form 1099-C on that forgiven debt. As I’ve mentioned here when discussing debt settlement, that forgiven amount can be considered income. Tax liability on that amount is something to be considered in determining the affordability of a debt settlement.
If debts are discharged in bankruptcy, is that considered income? No.
But if that’s the case, why am I hearing from reliable sources that debtors all over the country are receiving IRS Form 1099-Cs from former creditors? What’s going on? And what can YOU do about it?
It’s wise that you not ignore it. Talk to your tax professional about filing Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness), at least for the amount reported in the 1099-C. I have seen that it can take up to a few years for the IRS to determine that you under reported your income because you did not include income from a 1099-C. This form will report the essential facts to the IRS which will show that you are not responsible for the taxes on this “income.”
If you filed bankruptcy and received a Form 1099-C from a creditor, speak to your bankruptcy attorney.
While the creditor is allowed to file a 1099-C, they are required to make sure it is accurate, including indicating on the form that the debt was discharged in bankruptcy (see Box 6 of Form 1099-C, and IRS instructions). Even so, debtors will find it unsettling – even more so if they receive inquiry from the IRS next year, or the year after requesting an explanation as to what might be perceived as under-reported income.
Since it’s tax time, it’s important that I at least sound the alarm that something may not be right with creditors issuing IRS form 1099-Cs. If you’re in chapter 13 or if you have received a discharge, make sure you’re not getting a 1099-C that you do not deserve, and if you do be proactive to avoid problems down the road.