Cancellation of debt is generally considered taxable income by the IRS. You received some money in return for a promise to repay it. Once you no longer have an obligation to repay some or all of that debt, it effectively becomes your income.
However, like most tax laws, there are exceptions to this general rule. Make sure you report your cancellation of debt income and properly claim any applicable exceptions in order to avoid potential tax problems.
You may receive a form 1099-C from the lender that canceled your debt. If you get one of these forms, the IRS has a copy as well. Be sure you report it when you file your tax return.
If you don’t receive a 1099-C, you may want to contact your lender. Even if you don’t get one of these informational tax forms, you’ll still be expected to track your canceled debt income and report it on your tax return.
Exclusions from Taxable Income
Just because you report the 1099-C on your tax return, that doesn’t mean you’ll need to pay taxes on all of the reported income. There are a number of exceptions that could allow you to exclude the canceled debt from your taxable income.
One common exception is that debt canceled to the extent you are insolvent is not taxable. For example, let’s say you had $20,000 in debt canceled. At the time, your total assets were only worth $5,000. Only $5,000 of the forgiven debt will be taxable income. Many people have debts larger than their total amount of assets and can take advantage of this exclusion.
Debts forgiven in bankruptcy also qualify for an exclusion. However, this only applies to debts that were wiped out in the bankruptcy. If you had debt canceled and then later declared bankruptcy, you can’t claim this exception.
Several other exceptions are also available, including certain student loan debt forgiveness programs, such as the Public Service Loan Forgiveness initiative. Ask your tax professional if you aren’t sure how to categorize your canceled debt on your tax return.
If the IRS decides to claim your canceled debt is taxable income, you may receive an IRS notice of adjustment to your return. If you need help disputing the adjustment or negotiating an installment agreement to pay off your tax debt, contact a tax attorney for assistance.
Get help with IRS tax debt problems by calling The Gartzman Law Firm at (770) 939-7710. We can help you find a tax resolution option that fits your unique needs.