Written by a TurboTax Expert • Reviewed by a TurboTax CPAUpdated for Tax Year 2023 • May 6, 2024 11:04 AM
OVERVIEW
In most situations, if you receive a Form 1099-C from a lender after negotiating a debt cancellation with them, you'll have to report the amount on that form to the Internal Revenue Service as taxable income. Certain exceptions do apply.
Key Takeaways
- According to the IRS, nearly any debt you owe that is cancelled, forgiven, or discharged becomes taxable income to you.
- In most situations, if you receive a Form 1099-C, "Cancellation of Debt," from the lender that forgave the debt, you'll have to report the amount of cancelled debt on your tax return as taxable income.
- If your debt was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case, you're not responsible for taxes on that debt.
- If you can demonstrate to the IRS that you were insolvent at the time the debt was cancelled, you can similarly avoid taxes on that debt.
Cancelled debt
If your debt has gotten so large you can no longer afford to pay it, negotiating a debt cancellation with your lender might be just what you need in order to get by. Unfortunately, your next challenge might be a huge tax bill. In most situations, if you receive a Form 1099-C from a lender, you'll have to report the amount of cancelled debt on your tax return as taxable income. Certain exceptions do apply.
How the IRS classifies cancelled debt
You might consider it unfair that a debt you successfully cancel or negotiate away comes back to haunt you as taxable income. However, the IRS classifies cancelled debt as income because you received a benefit without paying for it.
When you first borrow money, you don't have to pay tax on the money you receive because you are bound by a contract to pay it back. If that contract gets cancelled without you paying the money back, the money is yours to do with as you please. Since you essentially received money for free, the cancellation of your obligation to pay it back usually makes it taxable income.
Form 1099-C
According to the IRS, nearly any debt you owe that is canceled, forgiven or discharged becomes taxable income to you. You should receive a Form 1099-C, "Cancellation of Debt," from the lender that forgave the debt. Common examples of when you might receive a Form 1099-C include charge-off of a credit card balance, repossession, foreclosure, return of property to a lender, abandonment of property, or the modification of a loan on your principal residence.
TurboTax Tip:
The Mortgage Forgiveness Debt Relief Act allows you to exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly—up to $1 million for other filing statuses—for tax years 2007–2020. The Consolidated Appropriations Act of 2020 extends the exclusion of canceled qualified mortgage debt up to $750,000 for tax years 2021–2025.
Mortgage forgiveness debt relief act
Due to the magnitude of the real estate market collapse that began in 2007, Congress passed the Mortgage Forgiveness Debt Relief Act. For calendar years 2007 through 2020, you can exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly—up to $1 million for other filing statuses. This also applies to debt that was discharged in 2021 provided that there was a written agreement entered into in 2020.This exclusion also applies to mortgage debt forgiven through a mortgage restructuring or in connection with a foreclosure.
The Consolidated Appropriations Act (CAA) was signed into law on December 27, 2020 as a stimulus measure to provide relief to those affected by the COVID-19 coronavirus pandemic. The CAA extends the exclusion of cancelled qualified mortgage debt from income for tax years 2021 through 2025. However, the maximum amount of excluded forgiven debt is limited to $750,000.
Bankruptcy and insolvency
Even if you receive a Form 1099-C from a lender, you still may be able to avoid taxation on the forgiveness of a debt. If your debt was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case, you're not responsible for taxes on that debt.
If you can demonstrate to the IRS that you were insolvent at the time the debt was cancelled, you can similarly avoid taxes on that debt. Certain other types of debt, including qualified farm indebtedness and qualified real property business indebtedness, can also avoid taxation in the event of cancellation.
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FAQs
In most situations, if you receive a Form 1099-C from a lender after negotiating a debt cancellation with them, you'll have to report the amount on that form to the Internal Revenue Service as taxable income. Certain exceptions do apply.
Do you have to file a 1099-C cancellation of debt? ›
In most situations, if you receive a Form 1099-C from a lender after negotiating a debt cancellation with them, you'll have to report the amount on that form to the Internal Revenue Service as taxable income. Certain exceptions do apply.
How badly does a 1099-C affect my taxes? ›
If you receive a 1099-C, you may have to report the amount shown as taxable income on your income tax return. Because it's considered income, the canceled debt has tax consequences and may lower any tax refund you are due.
Can I issue a 1099-C to someone that owes me money? ›
Form 1099-C is to be used only for cancellations of debts for which the debtor actually incurred the underlying debt. 2. An identifiable event has occurred. It does not matter whether the actual cancellation is on or before the date of the identifiable event.
When can a taxpayer be eligible to exclude the cancellation of debt from taxable income? ›
You may exclude the cancellation of indebtedness if it was a: Discharge of qualified principal residence indebtedness. Discharge of indebtedness in a title 11 case. Discharge of indebtedness to the extent insolvent (not in a title 11 case)
How do I report cancellation of debt on my tax return? ›
In general, you must report any taxable amount of a canceled debt as ordinary income on Form 1040, U.S. Individual Income Tax Return, Form 1040-SR, U.S. Tax Return for Seniors or Form 1040-NR, U.S. Nonresident Alien Income Tax Return (attach Schedule 1 (Form 1040), Additional Income and Adjustments to Income PDF) if ...
Can a creditor still collect after issuing a 1099-C? ›
However, in 2016, an IRS rule allowed debt collectors to file a 1099-C after 36 months of no payment. In this event, the account is still delinquent, but the debt hasn't been forgiven, so the lender may still try to collect.
How much tax will I pay on a 1099-C? ›
That depends on your overall taxable income. Your income, including amounts listed on your 1099-Cs, gets taxed at the normal progressive rate, which ranges from 10% to 37%. How much tax you will owe depends on your tax bracket, filing status, credits, and deductions.
What is the 36 month rule for 1099-C? ›
Thus, the failure of the debtor to make a payment for 36 months generally requires the creditor to file and furnish a Form 1099-C, even if the creditor has not ceased collection activities and discharged the debt.
Do I have to pay taxes on forgiven debt? ›
The law requires that you report all taxable canceled debt as income on your tax return, even if the amount is less than $600 and you didn't receive a Form 1099-C. Canceled debt is taxed at same rate as your ordinary income, which can be anywhere from 10% to 37% depending on your total taxable income.
Many people confuse a charge-off with the debt being forgiven. If your debt has been forgiven, you do not have to repay it. However, a charge-off means the creditor has written the debt off and transferred it to another collection firm to collect on.
What is the form for IRS forgiveness of debt? ›
Lenders or creditors are required to issue Form 1099-C, Cancellation of Debt, if they cancel a debt owed to them of $600 or more. Generally, an individual taxpayer must include all canceled amounts (even if less than $600) on the "Other Income" line of Form 1040.
What is an identifiable event for 1099-C? ›
Form 1099-C Reference Guide for Box 6 Identifiable Event Codes
| A | Bankruptcy |
|---|
| C | Statute of limitations or expiration of deficiency period |
| D | Foreclosure election |
| E | Debt relief from probate or similar proceeding |
| F | By agreement |
3 more rowsA lender files a 1099-C with the IRS – and they'll send you a copy of the form. While you don't have to file the 1099-C, you should use it to prepare and file your income tax return.
How to prove insolvency for 1099-C? ›
For example, if your Form 1099-C reports $1,000 of canceled debt and your liabilities are $500 more than your assets' fair market value, you can exclude $500 from your gross income. To do this, you must file Form 982. You can only claim balance-sheet insolvency to the IRS, not cash-flow insolvency.
Does a 1099-C affect your credit? ›
If the creditor doesn't send it before the tax deadline so you can file with the correct information, you'll need to file an amended return when you receive it. Though receiving a 1099-C doesn't hurt your credit, the canceled debt that led to it probably will.
How to avoid taxes on cancellation of debt? ›
Key Takeaways
However, certain types of canceled debts are not taxable under IRS rules - including debt forgiven as gifts, bequests, or inheritance, student loan debt under certain circ*mstances, and debt discharged through Chapter 7, 11, and 13 bankruptcy.
Do you get a 1099-C after bankruptcies? ›
However, there is a special exclusion in the Internal Revenue Code (Source, Cornell Law) which says any debt forgiven because of a bankruptcy discharge does not count as income. Whenever a lender forgives a debt for any reason they are required to issue a 1099-C.
