Discharged or forgiven debt can sometimes come back to haunt you in the form of a 1099-C from your lender. The IRS estimates that creditors will send 6.4 million such tax forms the 2011 tax year. That’s double what they sent last year. While lenders write off billions of dollars of unpaid or uncollectible debt, you meanwhile have to report that forgiven debt as income.
Some tax software programs may provide a way for Burlington County residents to explain the discrepancy, but there are other ways to qualify for an exemption and not have to pay taxes on your debt relief.
If you filed for bankruptcy, debts discharged in that process are not taxable. You can fill out a different IRS form letting them know that the debt was discharged during the bankruptcy process and you are exempt from paying taxes on that forgiveness.
If your debt surpassed your assets when the debt was forgiven, some (or maybe all) of that amount is exempt from taxes. Using IRS forms and worksheets you can list everything you owed when the debt was forgiven, including loans that are not normally dischargeable like student loans. This process also includes estimating the fair market value of all your assets and may require help from a professional.
Many creditors try sending erroneous 1099-Cs that are extremely old and grossly inaccurate. Sometimes they even show up in your mailbox years after you’ve discarded your bankruptcy documents. But, do not ignore any 1099-Cs you receive in the mail because the creditor has sent a duplicate copy to the IRS.
Source: usatoday, “Gone, but not forgotten: Canceled debt,” Sandy Block, May 5, 2012