Surprise! Your Cancelled Debt Is Taxable
It’s a huge relief to receive news of cancelled debt! Resolving debt is a huge accomplishment. However, don’t get too excited just yet. You may still owe taxes on that debt.
Why Do I Owe Taxes On Cancelled Debt?
The IRS considers cancelled or forgiven debt as income you have received and all income is taxable. While there are some exceptions to this rule, keep in mind that you are responsible for reporting your the cancellation to the IRS. Failure to report will result in penalties and fees, thus starting your cycle of debt all over again.
Form 1099-C is a Cancellation Of Debt (COD) report. Taxpayers with forgiven or cancelled debt will receive this form in the mail. Keep in mind that this form only applies to cancelled debts over $600. If you have received Form 1099-C, don’t panic. In order to resolve the taxes owed on your cancelled debt, you should attach Form 1099-C within your personal return. The IRS offers a guide on how to fill out Form 1099-C.
When Do I Not Owe Taxes On Cancelled Debt?
There are exceptions to every rule. While debts that have been cancelled are generally assumed to be taxable, there are a few exceptions.
- Insolvency (You are considered insolvent if you owe more than you own and the creditor forgives your debt for less than the original amount owed.)
- Debt cancelled in a bankruptcy.
- Debt cancelled by friends and family
- Tax deductible interest (You do not need to pay taxes on . Discharged student loans fall under this category.)
If your debt falls under one of the categories above, then you must complete Form 982 Reduction Of Tax Attributes Due To Discharge Of Indebtedness. Note: some taxpayers may have paid taxes on cancelled debt excluded from taxes. In that case, just file Form 1040x and attach your exemption on Form 982.
Debt cancellation is a huge relief. However, many taxpayers don’t know about the tax implications that come with it. In order to fully resolve your debt, you must determine if you owe taxes on said debt. The guide we created is an excellent way to begin your journey to financial freedom. However, the tax rules and regulations can be hard to understand.
At Lifeback Tax, we specialize in resolving tax debt. Our trustworthy team of tax professionals understands the intricacy behind the tax code. If you’re struggling with debt of any kind, feel free to reach out to us for a free consultation.