Debt Settlement And Its Impact On Your Income Tax Return

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Debt Settlement-Impact In Your Income Tax

When the amount settled is $600.00 or more, the creditor will report that as a loss in his tax return and will send you an IRS 1099-C form for you to report that in your income tax. You should consult your tax advisor when you receive that form and remind him to look into forgiven balance clauses, which we will mention later.

What is an IRS 1099-C?

Form IRS 1099-C is a form that informs a taxpayer that the creditor plans to “write off” the remaining portion of the unpaid balance on their taxes for that year. It is the creditor’s responsibility to file this form with the IRS when a settlement is reached or when a creditor has determined that a debt will never be paid. The rationale behind notifying the taxpayer in form IRS 1099-C is that the creditor may be liable to report the forgiven portion of the balance on their taxes. It is possible, however, that you are not liable to actually pay taxes on the settled debt.

What should you do if you receive a 1099-C for a settled debt?

You should inform your tax advisor that you have received the form and you need to report the forgiven portion of the balance as income on your tax return, unless you are claiming one of the exceptions below. The amount shown in box 2 of the 1099-C is the portion you are expected to report as income.

You might be able to use one of the following exceptions not to be responsible for paying taxes on the forgiven balance:

1. When the debt was discharged through filing bankruptcy.

2. When the amount settled is less than $600 dollars.

3. When the debt was due to certain real property business losses.

4. When the debtor was technically insolvent at the time of settlement. A debtor is considered insolvent when their debts exceed their assets.

5. When the discharge of the debt was treated as a gift.

6. When the debt was due to a qualified farm expense.

This information is provided for educational purposes only. We recommend that you seek the advice of a licensed tax advisor or an attorney to discuss your particular situation.

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