Between the months of January and April, I get dozens of calls from people wondering about a 1099-C they received in the mail. Unfortunately, many people don’t understand them and they just ignore them when preparing their taxes. Naturally, that is a big mistake.
Anytime you owe money to someone, and that person makes a decision to forgive the debt, then the IRS may be notified. The IRS will treat the forgiven debt as income.
For example, assume you owe $5,000 to a credit card company but you are struggling to pay them. The credit card company (with the help of some talented legal representation) might agree to take $2,000 and call it even. The credit card company would then forgive or cancel or write-off the other $3,000.
The credit card company will report that to the IRS using a 1099-C. These are mailed to the IRS in January in the year following the forgiveness. You will also receive a copy of the 1099-C by mail. The IRS will treat this as if you earned an extra $3,000 of income that year, and the IRS will expect you to pay taxes on the income. In many cases, this can take you from expecting a nice tax refund to having to owe money to the IRS.
However, there are some exceptions. You do not have to pay taxes if the debt was eliminated in bankruptcy. You do not have to pay taxes if you qualify as “insolvent” according to the IRS. You do not have to pay taxes if the debt that was cancelled was a mortgage loan deficiency following a foreclosure on your primary residence. An attorney can advise you whether you qualify for one of these exceptions.