Tax Issues with Debt Forgiveness

For many debtors, negotiating a lower amount of debt owed with a collection agency many seem like a blessing. Unfortunately, what most people don't realize is that once you get debt relief and some portion of your debts are forgiven, the IRS considers the amount forgiven as supplemental income and thus this income must be filed appropriately in your tax statement.

Debt Relief and Taxes

This example of the debt relief process can help highlight the tax issues:

  • If you owe an amount of $15,000 in debt and are behind on payments, your creditor may cut its losses and sell to a collection agency for $10,000.
  • For a while, the collection agency will pursue you for the full $15,000.
  • When they realize the extent of your financial problems, a negotiation conference will be held to discuss the possibility of some debt forgiveness.
  • Say you come to settlement on $12,000 in remaining debt, which will save you $3,000; a pretty hefty chunk.
  • The IRS considers that $3,000 as income and requires you to file a 1099-C form along with your federal income tax report and when April 15th comes this could cause a substantial tax bill.

Why the IRS Considers Debt Relief Taxable

When most consumers first learn of this legal technicality, all sorts of alerts go off in their mind: How can this be possible? The reason I settled for debt forgiveness was because I don't have any money. Now I have to pay more?

Just when you think you are debt free the IRS zeroes in for one last sting. The main problem is that most debtors, even most consumers for that matter, are unaware of the 1099-C form and what hits them even harder is that its sent by the collection agency they thought they were free of.

Getting Help

With bad credit rising in dollar amount each year, more and more consumers are hit with this surprise tax issue. If you are one of the many people faced with this situation it is important to seek legal advice immediately following the notification of you 1099-C form. Many tax-preparers are even unaware of the rules that surround this type of problem, which is why it is crucial for you to find someone who really knows what they are talking about. Ask to speak with a manager or supervisor to find out what exclusions you are eligible for. In this scenario exclusion and exemptions can be the best way to reduce or cancel out some of your debt.

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