Posted by Succentrix Business Advisors Butte

Cancellation of Debt Explained

Cancellation of Debt Explained

Cancellation of Debt (COD) happens if a creditor issues a debtor of a debt obligation. Borrowers can negotiate directly with the lender for debt cancellation. They can also benefit from debt relief through a debt reduction or bankruptcy program. Debts canceled by a lender are subject to tax as income. The canceled debt will be registered by the lender and declared to the borrower in the form of income of 1099 C.

The debts canceled last year represent the tax burden this year. If you had a debt cancellation in a previous year, you could expect to receive a 1099-C form from the lender, which includes the amount of debt forgiven. When you prepare the federal tax return for this year, you must include your canceled debt in your income.

IRS asks companies to send 1099-C to consumers if they cancel or forgive more than 600 debts. And do not be surprised if your creditor did not warn you. Companies are not required to inform you of the tax consequences of canceling or forgiving debts.

Receiving 1099-C fees can have a significant impact on tax refunds this year. Depending on the value of the canceled debts and other income, the amount deducted and the exemptions, the canceled debt can reduce the tax refund due or, worse, you can send the taxes due to the canceled debt.

Why Are Debts Canceled?

The creditor can cancel your debt for several reasons:

  • The limit status has expired.
  • You have entered into a debt settlement agreement to repay a portion of the debt and cancel the remaining.
  • The creditor's commercial policy is to stop recovering after a certain period.

Of course, finding that your debt has been canceled should be a good thing. And once you have settled the debt charges, you are no longer responsible for that specific debt.

Why Is It Considered As Income?

When you borrow money, the company extends a payment. This payment can take the form of a loan or credit purchase. You have a cash repayment agreement, so it is not subject to tax or income at that time. However, when the company terminates the contract, any outstanding money will be considered income and may be taxed.

If you get a 1099-C credit from one of your creditors, do not throw it away. This form is more than a debt cancellation ticket. Receiving this form also means that the IRS has received it and you expect it to include income from your tax return.

Include 1099-C with other financial documents when you go to your taxpayer. Make sure your tax preparer has knowledge and experience with this type of income or look for a tax expert who does. You do not want this problem to come back to haunt you. If you do not include the income, the tax return may be rejected; Otherwise, the IRS will correct the return and adjust the refund or send you an invoice corresponding to your needs. You may be subjected to pay a fine and other penalties if the income is not informed in time.

Tax Revenue Reports Not Included

There are situations in which your debt may be canceled, but you do not have to declare it as taxable income.

  • Debt liquidated in bankruptcy (unless the debt was for commercial or investment purposes).
  • Credits for students who have been pardoned by a tax-free educational institution and who have been working for many years for a qualified employer.
  • Debt derived from a mortgage of a principal residence lost on a mortgage, sold during a short sale or a restructured mortgage. You must still include this mortgage on your tax return, but on Form 982, and you must not incur any tax penalty.
  • You were at least insolvent in debts canceled at the time of cancellation. Becoming insolvent means that your debts are greater than the fair market value of your assets; that is, they have a negative net worth at the time of debt cancellation. To eliminate the exclusion of debt cancellation, you must submit IRS Form 982.

State Law

Your state's tax laws relating to canceled debts may differ from federal tax legislation. Consult a tax professional, for example, An accountant or lawyer to confirm your state's tax laws on the declaration of canceled debts as taxable income.

Succentrix Business Advisors Butte