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Taxes Owed On Forgiven Debt


TaxesMany people took advantage of the opportunity of settling debt for less then full balance. While this often is considered a good thing, there may be taxes owed on the amount that was forgiven. The IRS considers debt that is canceled as income if the forgiven amount is more then $600.00. Debt collectors are required by law to issue a 1099-c with the IRS and to send the debtor a notice as well. The debtor must then claim that forgiven amount as income on their federal income tax return.

The problem begins with the letter from the debt collector. Many people who have their debt settled for less then full balance are finally relieved to have that creditor out of their lives. When they receive a letter from the debt collector they may not even open it because they believe the issue has been resolved. Unfortunately, that is no excuse for not paying Uncle Sam what you owe. An incorrect tax return could be filed and only later find out of the error.

If a debt settlement agency was used to settle the debt, these agencies were to inform their customers of the possibility of the tax issue. Sometimes this was not done or the customer simply did not understand what a 1099-c form means. It often takes many months for a debt to be settled so some customers simply forgot about the taxable income. For whatever the reason, people may now owe the IRS and are confused as to what they need to do.  

With the large amount of homeowners who defaulted on mortgage loans on their primary residences and wanted to do a short sale, this became a major block to accepting the contract for the sale. If they did not have enough money to pay the higher taxes they were unable to accept the short sale offer. With the Mortgage Forgiveness Debt Relief Act which became effective December 20, 2007, homeowners were provided an exclusion for some of the forgiven mortgage debt for up to $2 million dollars in calendar years 2007 through 2012. There are exceptions so check with a tax attorney to fully understand your situation.

If you get a 1099-c, make sure you understand the amount of forgiven debt stated on the form. It may be higher then expected because the forgiven debt also includes the other fees that were attached such as attorney fees etc. If you have further questions concerning this issue contact a local tax attorney. They have the knowledge to help you through the process.

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