What do I do with an IRS Form 1099-C?

The quick answer is file a Form 982.  But let’s explore what a Form 1099-C is, why you got one and what to do now.

What is a Form 1099-C?

Originally, the reason for the Form 1099-C was to prevent people or employers from claiming paychecks were a “loan” rather than income. This would allow income and payroll taxes to be avoided in order to defraud the IRS.  The IRS considers canceled debt the same as income for tax purposes, even though you received no actual income.

When you owe money to a creditor and don’t pay it back on time, the creditor makes an accounting entry called a “write off” or a “charge off.”  Essentially, the creditor is telling the IRS that it is not counting on getting paid back on this account and they won’t pay taxes on it.  The creditor issues a Form 1099-C to shift the risk of tax to you, the debtor. The IRS looks to you to pay the tax on that amount, as if you received income.  I know, you didn’t get any income and could sure use that money now – but this is a fictional income for tax reasons.  As in many legal situations, you have rights but have to assert those rights or the law will act as if you have waived them.

Here is a copy of a blank current 2011 Form 1099-C.

Tax time and the IRS wants 1099c

Why did I get a Form 1099-C?

You received a Form 1099-C because your creditor is no longer counting on being paid back – for tax purposes only.

Does that mean I don’t owe the debt anymore?

No, you still legally owe the debt.  As a matter of law, a 1099-C form is an informational filing with the IRS and does not legally discharge or cancel the debtor’s obligation to pay the debt. In re Zilka, 407 BR 684 (2009, Bk Ct. WD Penn).  If you have paid taxes on the amount of a Form 1099-C and later on repay the creditor, the creditor should issue a Form 1099-C “correction” amount, and you would need to amend your tax return so you are not overpaying income tax.

That’s just great!   If I’m understanding you, I still owe the debt AND I have to pay income tax on the amount on the Form 1099-C?

Not so fast – and this is why you should get help from a tax professional to file your annual income taxes when you get a Form 1099-C.  Just because you received a Form 1099-C from a creditor doesn’t mean you owe income tax on it. It does mean you may need to file an additional form in order to explain to the IRS why you don’t owe taxes on the Form 1099-C.

The IRS created Form 982 so you can show them that you don’t owe tax on the Form 1099-C amount.  Common reasons for needing to file a Form 982 are when the debt on the Form 1099-C was discharged in bankruptcy, is due to a home mortgage that went through foreclosure or a short-sale, or you are insolvent.

If the debt was part of a bankruptcy – here’s what you need to do:

  • Open Form 982.
  • Check box 1a – “Title 11 case” refers to the entire Bankruptcy Code, not the chapter of bankruptcy you went through (examples: Chapter 7 or Chapter 13).
  • Lines 2 and 10a: Put the amount discharged in your bankruptcy.

Other situations when you do not have to pay taxes on the 1099-C amount:

  • You are insolvent: all your liabilities are greater than your assets. Assets include exempt assets such as retirement plans.  The formula is to figure out if the fair market value of your assets was less than the total of your liabilities (debts), at the time the Form 1099-C was issued.  If you owe more than you own, then you are insolvent and the amount on the Form 1099-C is not included in your gross income on your tax return.  If you own more than you owe,  then you will need to add the amount of the Form 1099-C to your gross income until you get to even.
  • Loans from your primary residence (used to buy, refinance or improve your home) through 2012.

Here is an example to help you understand the impact of a Form 1099-C on your taxes:

Credit Card Company sends a Form 1099-C in the amount of the $4,000 balance of the Jones’ credit card debt.  The Jones’ have not filed for bankruptcy. Immediately before the cancellation, the Jones’ total debt was $21,000 and the fair market value of their assets was $17,500. Because the Jones’ debt is more than their assets, the Jones’ were insolvent when the Form 1099-C was issued. The amount of the insolvency was $3,500 ($21,000 ? $17,500). The Jones’ may exclude only $3,500 of the $4,000 debt cancellation from income because that is the amount of their insolvency.   The Jones’ may also need to reduce certain tax attributes by the $3,500 of excluded income. The remaining $500 of canceled debt must be included in their gross income for that tax year.

As you can see, the IRS rules can be a bit tricky. It is always a good idea to seek help from a tax preparer to make sure your tax returns are filled out correctly.

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