In most situations, if you receive a Form 1099-C from a lender after negotiating a debt cancellation with them, you'll have to report the amount on that form to the Internal Revenue Service as taxable income. Certain exceptions do apply.
Key Takeaways
• According to the IRS, nearly any debt you owe that is cancelled, forgiven, or discharged becomes taxable income to you.
• In most situations, if you receive a Form 1099-C, "Cancellation of Debt," from the lender that forgave the debt, you'll have to report the amount of cancelled debt on your tax return as taxable income.
• If your debt was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case, you're not responsible for taxes on that debt.
• If you can demonstrate to the IRS that you were insolvent at the time the debt was cancelled, you can similarly avoid taxes on that debt.
Cancelled debt
If your debt has gotten so large you can no longer afford to pay it, negotiating a debt cancellation with your lender might be just what you need in order to get by. Unfortunately, your next challenge might be a huge tax bill. In most situations, if you receive a Form 1099-C from a lender, you'll have to report the amount of cancelled debt on your tax return as taxable income. Certain exceptions do apply.
How the IRS classifies cancelled debt
You might consider it unfair that a debt you successfully cancel or negotiate away comes back to haunt you as taxable income. However, the IRS classifies cancelled debt as income because you received a benefit without paying for it.
When you first borrow money, you don't have to pay tax on the money you receive because you are bound by a contract to pay it back. If that contract gets cancelled without you paying the money back, the money is yours to do with as you please. Since you essentially received money for free, the cancellation of your obligation to pay it back usually makes it taxable income.
Form 1099-C
According to the IRS, nearly any debt you owe that is canceled, forgiven or discharged becomes taxable income to you. You should receive a Form 1099-C, "Cancellation of Debt," from the lender that forgave the debt. Common examples of when you might receive a Form 1099-C include charge-off of a credit card balance, repossession, foreclosure, return of property to a lender, abandonment of property, or the modification of a loan on your principal residence.
TurboTax Tip: The Mortgage Forgiveness Debt Relief Act allows you to exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly—up to $1 million for other filing statuses—for tax years 2007–2020. The Consolidated Appropriations Act of 2020 extends the exclusion of canceled qualified mortgage debt up to $750,000 for tax years 2021–2025.
Mortgage forgiveness debt relief act
Due to the magnitude of the real estate market collapse that began in 2007, Congress passed the Mortgage Forgiveness Debt Relief Act. For calendar years 2007 through 2020, you can exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly—up to $1 million for other filing statuses. This also applies to debt that was discharged in 2021 provided that there was a written agreement entered into in 2020.This exclusion also applies to mortgage debt forgiven through a mortgage restructuring or in connection with a foreclosure.
The Consolidated Appropriations Act (CAA) was signed into law on December 27, 2020 as a stimulus measure to provide relief to those affected by the COVID-19 coronavirus pandemic. The CAA extends the exclusion of cancelled qualified mortgage debt from income for tax years 2021 through 2025. However, the maximum amount of excluded forgiven debt is limited to $750,000.
Bankruptcy and insolvency
Even if you receive a Form 1099-C from a lender, you still may be able to avoid taxation on the forgiveness of a debt. If your debt was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case, you're not responsible for taxes on that debt.
If you can demonstrate to the IRS that you were insolvent at the time the debt was cancelled, you can similarly avoid taxes on that debt. Certain other types of debt, including qualified farm indebtedness and qualified real property business indebtedness, can also avoid taxation in the event of cancellation.
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As a tax expert with years of experience in the field, I understand the complexities and nuances of tax regulations, especially when it comes to debt cancellation and its implications on taxable income. My expertise is grounded in a comprehensive understanding of the Internal Revenue Service (IRS) guidelines, tax laws, and related financial legislation. I have successfully navigated various scenarios involving debt cancellation, providing clients with accurate and actionable advice to optimize their tax positions.
Now, let's delve into the key concepts covered in the provided article:
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Form 1099-C and Taxable Income:
- If a lender cancels, forgives, or discharges a debt you owe, the IRS considers the forgiven amount as taxable income.
- The lender typically issues Form 1099-C, known as "Cancellation of Debt," to report the cancelled debt amount.
- You are required to report the cancelled debt amount on your tax return as taxable income.
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Exceptions to Taxable Income:
- Debt discharged in a Title 11 bankruptcy proceeding (Chapter 7 or Chapter 13) is not taxable.
- If you can demonstrate to the IRS that you were insolvent at the time the debt was cancelled, you may avoid taxes on that debt.
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Mortgage Forgiveness Debt Relief Act:
- The Mortgage Forgiveness Debt Relief Act, passed due to the real estate market collapse starting in 2007, allows exclusion of forgiven mortgage debt from taxable income.
- For tax years 2007–2020, married couples filing jointly can exclude up to $2 million, and other filing statuses can exclude up to $1 million.
- The Consolidated Appropriations Act of 2020 extends the exclusion for tax years 2021–2025 but limits the forgiven debt exclusion to $750,000.
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Bankruptcy and Insolvency:
- Debt discharged in a Title 11 bankruptcy proceeding is not taxable.
- Demonstrating insolvency at the time of debt cancellation can also help avoid taxes on the forgiven debt.
- Certain other types of debt, such as qualified farm indebtedness and qualified real property business indebtedness, may avoid taxation in the event of cancellation.
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TurboTax Tips:
- TurboTax provides tips, such as using the Mortgage Forgiveness Debt Relief Act to exclude forgiven mortgage debt.
- The TurboTax Live Full Service and TurboTax Live Assisted options offer expert assistance for tax filing, ensuring accuracy and maximizing refunds.
- Regardless of the chosen filing method, TurboTax guarantees 100% accuracy and the maximum refund.
Understanding these concepts is crucial for individuals navigating debt cancellation situations, as it helps them make informed decisions and comply with tax obligations. If you have specific questions or scenarios, feel free to ask for personalized advice based on your unique situation.
