Concerned About Receiving a 1099-C on Forgiven Debt?

How to Reduce or Eliminate the Impact of a 1099-C on Settled Debt

Are you concerned about entering a debt settlement program because others have warned you about the tax implications cutting into your savings? 

Have you paid off a debt through debt settlement and now dread the trip to the mailbox because you might receive a 1099-C, showing you owe the IRS money on your savings?

Before you panic or make a decision based on fear of the unknown, here is what you need to know about the possible impact of a 1099-C and what you can do to reduce or eliminate the tax implication altogether.

What is a 1099-C?

Debt settlement attempts to reduce the amount you must pay a creditor, lowering the payoff on existing debt. When you pay a debt off, but pay less than the balance, including late fees, interest, and penalties, it can be considered “income” by the IRS. 

While it hardly seems fair to place an additional tax on someone struggling to pay their bills, the IRS tax code states that anyone receiving debt forgiveness greater than $600 could receive a 1099-C. If you receive the tax form, you must claim the amount listed as income. 

Taxation on a 1099-C: You pay taxes as ordinary income. 

Who Can Receive a 1099-C: A lender can issue a 1099-C to anyone who receives a financial benefit from debt reduction, although this rarely happens.  Accounts might include debt settlement, foreclosure, loan forgiveness, or other discharged debt you are no longer liable to pay.  

Do You Qualify for an Exemption? 

The IRS offers a few exceptions that could reduce or eliminate your tax liability if you receive a 1099-C from a former creditor. Exemptions include: 

1. The debt canceled was a gift or an inheritance.
2. The canceled debt would be deductible if it was business or farm debts.
3. A qualified price reduction on the purchase of a home, offered by the seller.
4. A Judge discharged the debt through bankruptcy. Debts which are included in a chapter 7 bankruptcy discharge are not subject to taxation. 
5. Some student loan forgiveness. Loan forgiveness obtained through an occupation such as teachers or physicians working in high need areas do not have to report the forgiven amounts. Other student loan forgiveness qualifying for an exemption include a discharge due to a closed school, the Public Service Loan Forgiveness program, or total disability of the loan recipient.   
6. Insolvency is the most widely used exception by those enrolled in debt settlement programs. Being broke is not the same as insolvency. You must prove to the IRS that on the date of the discharge, you had more liabilities than you had in assets by completing the worksheet in IRS publication number 4681

In 2018, tax filers lost the primary home exemption. Homeowners who lost their primary home to foreclosure from 2006 to 2017 enjoyed an exemption from taxation if the home sold for less than the amount they owed. 

In Practice

Creditors do not always issue a 1099-C on debt canceled due to debt settlement, and if the debt was sold to a third party prior to settlement, the likelihood of receiving a 1099-C goes down even further.

Final Thoughts

It is possible to receive a 1099-C when you settle debts with a creditor for less than you owe. If you do receive the form, you must include it on your taxes to avoid further interest and penalties. Companies have until January 31 of the tax filing year to mail you your 1099-C. So, if you don’t receive one by the end of January, you are likely off the hook for the tax obligation of your settled debt.