1099-C: What You Need to Know About This IRS Form

By: Jordan Wathen, The Motley Fool

Most people are in for a surprise when they receive a 1099-C, never realizing that canceled debt is often treated just like any other dollar of ordinary income. Creditors record canceled debts on a form 1099-C, which is then sent to the debtor and the IRS.

Some common triggers for receiving a 1099-C include forgiven loan balances (like a canceled credit card debt), a home foreclosure or short sale (which results in the sale of a home at a price below your mortgage amount), or if you simply haven’t paid a debt in the last three years and the lender hasn’t tried to collect in the past year.

While most canceled debts are taxable, a lender is only required to send you a 1099-C if it forgives more than $600 in debt in a single tax year.

What a 1099-C means — and what it doesn’t
Importantly, the fact you received a form 1099-C does not necessarily mean that you are no longer on the hook to pay your debt. Creditors have to consider a debt forgiven if you haven’t paid in three years and they haven’t made meaningful attempts to collect in the last year (Code H). It’s quite possible to receive a 1099-C only to receive notices for collection immediately after. It may be in your best interest to speak to your creditors to see if your debt has actually been canceled.

In addition, not all forgiven debt is reported as income. Debt discharged in bankruptcy is not treated as income. Under certain circumstances where a borrower is deemed to be insolvent, some or all of your debt may not not be reportable as income. Likewise, some student loan debt may not be considered income when forgiven. Publication 4861 provides a worksheet to determine insolvency, in addition to describing which student loan debts can be forgiven without any tax implications.

Since the financial crisis, some forgiven mortgage debts have also been excluded as income. Unfortunately, the exclusion has recently been approved for only one year at a time — it was extended to the 2014 tax year by a December 2013 vote by Congress — and whether it will extend into 2015 remains a question mark. Two pieces of legislation — H.R. 1002 and S. 608 — are currently circulating in Congress, leaving the mortgage exclusion up in the air for tax years 2015 and beyond. If history is any guide, Congress will save this decision for a year-end vote, making it an important piece of legislation to watch if you expect to have canceled mortgage debt in 2015.

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