Debt settlement and income taxes are deeply interlinked. This is because of the fact that the amount of debt that is forgiven by a settlement was supposed to be paid to the creditors. Since you are not paying it, you are saving it. Whatever you save is the income on your part and therefore, the forgiven debt is your income. Now that income is taxable, the forgiven debt is taxable. This is a new regulation that has been issued by the IRS. Thus whenever, you get a debt settlement, the creditor will inform the IRS about the forgiven amount by issuing 1099-C to the IRS. The IRS will then in return issue the same to you and you need to address the same in you tax return. If you fail to do so, you will have to pay penalties and interests along with the tax on your income inclusive of the forgiven debt! Debt settlement becomes taxable if the forgiven amount is greater than $600. If the amount forgiven for you is less than that, you will not be taxed.
1099-C may not have taxable debt in it under certain conditions. These conditions include:
- Insolvency: If you were insolvent during settlement, your settlement is not taxed. Putting in simple words, if your totals debts exceeded the net value of the assets you had during settlement, the forgiven amount is not taxed even if it is more than $600.
- The forgiven amount if considered as gift, you need not pay tax on your settlement.
- The debt forgiveness was a part of the bankruptcy proceeding, you will not be taxed.
- If your indebtedness occurred because of a loss in real property business, your debt settlement will not be taxed!
If you are reporting insolvency, you need to fill the form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness which is issued by the IRS. You can also write and attach a letter with detailed calculation of the debts that you had and the assets you had during settlement along with your tax return and send it to IRS!
Source by Percy Wilson