What is CANCELLATION OF DEBT INCOME (1099-C) and what does it mean to the IRS?
Let’s say you owe $50,000 on a credit card. You know you cannot pay this amount anytime now or in the near (or distant) future and you are able to negotiate with the credit card company to accept a smaller amount to extinguish the debt – $20,000. What happens to that other $30,000? Sure, you may not owe it any further to the credit card company, but Uncle Sam still wants a piece.
Why would Uncle Sam be entitled to tax money, on money you never even had?
The IRS does not see the above-referenced scenario as one transaction – rather it sees it as 2 transaction. One transaction was the Credit card company giving you $30,000, and the other transaction is you taking that imaginary money and paying that same $30,000 back to the credit card company. Therefore, from the IRS’ standpoint, you earned income on $30,000 – and Uncle Sam wants his piece. Sounds fair, right….The IRS is now going to tax you on money you never touched.
As provided by the IRS:
- “A debt includes any indebtedness whether you are personally liable or liable only to the extent of the property securing the debt. Cancellation of all or part of a debt that is secured by property may occur because of a foreclosure, a repossession, a voluntary return of the property to the lender, abandonment of the property, or a principal residence loan modification.”
Therefore, the moment that a company forgives your debt and issues you a 1099-C, the IRS will take notice, and expect its cut. You must report any taxable amount of a cancelled debt for which you are personally liable, as ordinary income from the cancellation of debt, on Form 1040 (PDF) or Form 1040NR (PDF) and associated schedules, as advised in Publication 4681 (PDF), Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). You must report the taxable amount of a taxable debt whether or not you receive a Form 1099-C.
But, there are limitations –
As further provided by the IRS:
- “If you receive a Form 1099-C but the creditor is continuing to try to collect the debt, then the debt has not been cancelled and you do not have taxable cancellation of debt income. “
And, to confuse you even further –
- “If your debt is secured by property and that property is taken by the lender in full or partial satisfaction of your debt, you are treated as having sold that property and may have a taxable gain or loss. The gain or loss on such a deemed sale of your property is an issue separate from whether any cancellation of debt income associated with that same property is includable in gross income.”
Yes, if you had property used to secure a debt, and the property is sold to satisfy the debt, you may also have a gain/loss for said property – which is a separate issue with tax liability as well.
S. MATTHEW GOLDING, ESQ, EA
S. Matthew Golding is one of only a few attorneys licensed in both New York & California, and has accumulated 15 years of legal experience, as well as experience as an Enrolled Agent (the highest credential awarded by the IRS). His domestic and international law practice emphasizes the representation of clients worldwide in matters involving Civil & Criminal Tax, Estate Planning, & Wealth Management. Matthew’s clients include U.S. and foreign citizens living abroad in countries such as Iraq, Japan, Afghanistan, Indonesia, South Africa, Pakistan, and Korea. Matthew is currently enrolled in one of the nation’s Top Master of Tax Law Programs at the University of Denver in a distance program designed for experienced professionals. He worked his way through school, graduating University of Denver and Whittier Law School and earning Dean’s List distinction at both institutions.
- Member, State Bar of California, 1999-Present (Inactive 2004-2005 while launching NY practice)
- Member, State Bar of New York, 2004-Present
- Enrolled Agent, Federally Licensed Tax Practitioner
- Admitted, United States Tax Court
- Real Estate Broker, California Department of Real Estate
Having achieved Enrolled Agent status, Matthew is one of a handful of attorneys licensed to represent individual and corporate clients nationwide before the IRS, IRS Appeals Board, Tax Courts, and Federal Courts. He has been quoted in several news publications