Interest payments add up. Car payment, credit card payments, business expenses, mortgage and recurring monthly bills add up, and they can add up quickly. One day you are making payments adding up to $500, and in the blink of an eye you could be staring down the barrel of $5,000 a month. How does it get so bad? We are all human and we won’t focus on that.
If you speak with your creditors, sometimes they will restructure your debt, or offer you solutions to help reduce the debt burden. A credit card company may even (after months of battle) end up forgiving a large portion of your balance due. It won’t end there, however. At the end of the year, you will start seeing a new tax form. Not your 1099-INT or your W-2, but a little thing called the 1099-C: Debt cancellation.
What the heck? How can you pay tax on debt cancellation? You didn’t receive any money! Well, if you look at the big picture, you borrowed money, that now you don’t have to pay back. Sneaky, but you did in fact receive money; you just don’t have it now!
There are some ways around paying tax on the “income†portion of your debt forgiveness; the dreadful number on your 1099-C.
- First, determine the type of debt that was forgiven. Was it business? Rental? Or personal? The answer to this helps you determine where to put the initial figure on your tax return. (Sch. C, Sch. E., or right on the 1040)
- Determine whether you are personally liable. If box 5 is checked on the 1099-C, then you appear to be on the hook to have to pay the tax.
- WAIT! You have an out. Step 3, determine whether you can exclude the income, even if box 5 is checked. If you received this while in bankruptcy or because of insolvency (only makes sense right?) then chances are you won’t have to pay tax on it. At least to the extent you are insolvent. (HINT: Publication 4681 and Form 982)
- Follow the form trail I have left you and you should already be where you need to be.
It may not be a pretty painting, but at least now you can put the paint brush down and get on with your life.
Kevin
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