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Tax on cancelled debt: Handling IRS Form 1099-C

September 9, 2023 By Israel Padilla

What You Need to Know About IRS Form 1099-C

If you’re reading this, you might have received a Form 1099-C from a creditor or a federal agency. This form reports the cancellation of debt, which means that someone has forgiven or written off a debt that you owed. Sounds good, right? Well, not so fast. There’s a catch: you may have to pay taxes on the canceled debt as if it were income. Ouch!

But don’t worry, we’re here to help you understand what Form 1099-C is, why you received it, and what you need to do with it. In this blog post, we’ll cover:

What is Form 1099-C?

Form 1099-C is an information return that reports the cancellation of debt. The IRS considers canceled debt as income, because it’s money that you borrowed and didn’t have to pay back. Therefore, you may have to include the canceled debt in your taxable income and pay taxes on it.

Form 1099-C has two copies: Copy A and Copy B. Copy A is sent to the IRS by the creditor or the federal agency that canceled the debt. Copy B is sent to you, the debtor, for your records and tax reporting purposes.

Form 1099-C shows the following information:

  • The name and address of the creditor or the federal agency that canceled the debt.
  • The name and address of the debtor.
  • The account number of the debt.
  • The date of the identifiable event that triggered the cancellation of debt.
  • The amount of debt canceled.
  • The fair market value of any property given up by the debtor in exchange for the cancellation of debt.
  • A checkbox indicating whether the debtor was personally liable for the debt or not.
  • A code indicating the type of identifiable event that triggered the cancellation of debt.

Who sends Form 1099-C?

Form 1099-C is sent by applicable financial entities and federal government agencies that cancel $600 or more of debt owed by a debtor. Applicable financial entities include banks, credit unions, credit card companies, mortgage lenders, student loan lenders, and other financial institutions that lend money or extend credit. Federal government agencies include the Department of Education, the Department of Housing and Urban Development, the Department of Agriculture, and others that cancel debts related to federal programs or loans.

Who receives Form 1099-C?

Form 1099-C is received by debtors whose debts have been canceled by applicable financial entities or federal government agencies. You may receive a Form 1099-C if:

  • You negotiated a settlement with your creditor to pay less than what you owed.
  • You filed for bankruptcy and your debts were discharged by the court.
  • You had a foreclosure, a short sale, or a deed in lieu of foreclosure on your home.
  • You had a repossession or a voluntary surrender of your car or other property.
  • You had a student loan forgiven or canceled by the Department of Education or another federal agency.
  • You had a debt that was canceled due to an identifiable event, such as the expiration of the statute of limitations, the death of the debtor, or the cancellation of debt as a gift.

How to report Form 1099-C on your tax return?

If you received a Form 1099-C, you may have to report the canceled debt as income on your tax return. To do so, you need to:

  • Check the amount of debt canceled in Box 2 of Form 1099-C.
  • Check the code for the identifiable event in Box 6 of Form 1099-C.
  • Report the amount of debt canceled as “Other income” on Line 8 of Schedule 1 (Form 1040 or 1040-SR).
  • Attach Schedule 1 to your Form 1040 or 1040-SR.
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For example, if you received a Form 1099-C showing that your credit card company canceled $5,000 of your debt and the code for the identifiable event was “F” (by agreement), you would report $5,000 as “Other income” on Line 8 of Schedule 1 and attach it to your Form 1040 or 1040-SR.

How to avoid paying taxes on Form 1099-C?

Although canceled debt is generally taxable, there are some exceptions and exclusions that may allow you to avoid paying taxes on it. These include:

  • The bankruptcy exclusion: If you filed for bankruptcy and your debts were discharged by the court, you don’t have to pay taxes on the canceled debt. However, you need to file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your tax return.
  • The insolvency exclusion: If you were insolvent (your debts exceeded your assets) immediately before the cancellation of debt, you don’t have to pay taxes on the canceled debt up to the amount of your insolvency. However, you need to file Form 982 and attach it to your tax return, along with a statement showing your assets and liabilities before the cancellation of debt.
  • The qualified principal residence indebtedness exclusion: If you had a foreclosure, a short sale, or a deed in lieu of foreclosure on your main home, and the debt was used to buy, build, or improve your home, you don’t have to pay taxes on the canceled debt up to $2 million ($1 million if married filing separately). However, this exclusion only applies to debts canceled in 2021 or earlier. For debts canceled in 2022 or later, you need to meet additional requirements to qualify for this exclusion. You also need to file Form 982 and attach it to your tax return.
  • The qualified farm indebtedness exclusion: If you incurred farm debts in connection with your farming business, and at least half of your income for the previous three years came from farming, you don’t have to pay taxes on the canceled farm debt. However, you need to file Form 982 and attach it to your tax return.
  • The qualified real property business indebtedness exclusion: If you incurred debts in connection with your trade or business involving real property (such as rental property), and you elected to treat them as qualified real property business indebtedness, you don’t have to pay taxes on the canceled debt up to the basis of your depreciable real property. However, you need to file Form 982 and attach it to your tax return.
  • The student loan forgiveness exclusion: If you had a student loan forgiven or canceled by the Department of Education or another federal agency under certain programs that require you to work in certain professions or areas for a specified period of time, you don’t have to pay taxes on the canceled student loan. However, this exclusion does not apply to student loans that are forgiven or canceled due to death or disability. You also need to file Form 982 and attach it to your tax return.
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What to do if you didn’t receive Form 1099-C

If you know that your debt was canceled or forgiven by a creditor, but you didn’t receive a Form 1099-C from them, you should contact them and request one. Sometimes creditors may forget or delay sending out the form, or they may send it to an old address. You are still responsible for reporting the canceled debt as income on your tax return, even if you don’t receive a Form 1099-C. You can use other documents, such as account statements or settlement letters, to determine the amount of canceled debt and the date of cancellation.

Tips to avoid Form 1099-C surprises

Receiving a Form 1099-C can be a shock, especially if you didn’t expect to owe taxes on your canceled debt. Here are some tips to help you avoid or minimize the impact of Form 1099-C surprises:

  • Keep track of your debts. If you have any debts that are past due or in collections, keep an eye on them and monitor any changes in their status. If you receive any notices or offers from your creditors about settling or canceling your debt, read them carefully and understand the tax implications.
  • Negotiate with your creditors. If you are struggling to pay your debts, you may be able to negotiate with your creditors for a lower amount or a payment plan. However, be aware that any amount of debt that is forgiven or canceled may be reported to the IRS as income. You may want to ask your creditors to issue a Form 1099-C for a lower amount or not at all, but they are not obligated to do so.
  • Check your Form 1099-C for errors. If you receive a Form 1099-C from a creditor, make sure that the information on it is correct. Sometimes creditors may make mistakes or report outdated or inaccurate information. For example, they may report a higher amount of canceled debt than what you actually owed, or they may report a cancellation date that is different from when the debt was actually canceled. If you find any errors on your Form 1099-C, contact your creditor and ask them to correct them and send you a new form.
  • Claim an exception or exclusion if you qualify. If you receive a Form 1099-C for a canceled debt that is not taxable to you because of an exception or exclusion, make sure that you claim it on your tax return. You may need to fill out Form 982 and attach it to your return. You may also need to provide documentation to support your claim, such as a bankruptcy discharge order, a statement of insolvency, or evidence of qualified principal residence indebtedness.
  • Plan ahead for your tax bill. If you receive a Form 1099-C for a canceled debt that is taxable to you and you don’t qualify for any exception or exclusion, be prepared to pay taxes on it. You may want to adjust your withholding or make estimated tax payments throughout the year to avoid underpayment penalties and interest. You may also want to consult a tax professional for advice on how to deal with your specific situation.