Form 1099-C, Cancellation of Debt, reports cancelled debt to both you and the IRS.
- Cancellation of Debt on IRS Form 1099-C, Cancellation of Debt, automatically becomes Taxable Income on Line 21 of Form 1040.
- IRS tax Form 982, Reduction of Tax Attributes, may allow exclusion of cancelled debt from taxable income.
- Insolvency is just one exclusion available on IRS Form 982, Reduction of Tax Attributes.
Hi, I’m Gary Bode, an insolvency CPA accountant with a virtual office to help you wherever you live. Yes, I prepare debt cancellation tax returns. Form 982 became a niche for us during the Recession, probably because of this website drawing clients from across the country. But, sadly, I’m expecting cancelled debt to remain a huge issue in the 2016 tax season (for 2015 tax returns. That’s based on proactive calls from Folks expecting a 2015 Form 1099-C, and chatter from the CPA and financial fields. I’ll present the most common FAQs I field on IRS tax Form 1099-C and Form 982. Plus a few tips I’ve learned over the years as an insolvency CPA. The Form 982 instructions get complex quick and you’d have to know some tax and accounting concepts to have them make sense.
Please note our testimonials and post comments feature CPAs and other tax preparers.
Debt cancellation in Box 2 of Form 1099-C automatically becomes Taxable Income on Line 21 of Form 1040 unless you file Form 982
Cancelled debt springs from bad luck and financial distress. So the IRS making cancelled debt taxable income seems unfair. Especially since it feels like you’re being taxed on money you never had. The IRS has multiple exceptions and exclusions that may allow you to avoid being taxed on some, or all, of the cancelled debt listed in Box 2 of Form 1099-C. Insolvency is one exclusion reported on Form 982. However we often use the insolvency exclusion with exclusions on Form 982.
Update: The discharge of qualified principal residence indebtedness is gone in 2015, making IRS insolvency even more important. Most folks don’t think Congress will extend it into the 2016 tax season (for 2015 tax preparation). Note that sometimes your insolvency CPA can help you establish an earlier date for your primary residence Form 1099-C depending on the what documentation you have from the lender.
How much tax might you pay on cancellation of debt?
20-35% of the amount of Box 2 of Form 1099-C, Cancellation of Debt. Ouch. Depends on your marginal tax bracket and what state you live in.
What is IRS insolvency?
Per the IRS insolvency worksheet it’s what you owe less the Fair Market Value of what you own; as of the date on the Form 1099-C. You can exclude cancelled debt income to the extent of your insolvency.
- Full exclusion. Your insolvency is equal or greater than your cancelled debt. The entire cancelled debt goes on Form 982 and $0 flows to Line 21 of Form 1040.
- Partial insolvency. If you have, say, a $150,000 Form 1099-C and you were $100,000 insolvent, the $100,000 goes on Form 982 and is non-taxable, but the $50,000 goes to Line 21 , Other Income, of Form 1040 and becomes taxable income.
- No insolvency, The entire amount in Box 2 of Form 1099-C flows to line 21 of Form 1040 and becomes taxable income.
The Insolvency Exclusion for Cancelled Debt on Form 982
Per the IRS: you were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation. I like my explanation above better. The IRS insolvency worksheet seems straight forward, but becomes complex in some cases. The IRS provides some good examples in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abadonments.
Use the IRS Insolvency Worksheet to determine your amount of insolvency. With Clients I go through the insolvency worksheet by phone because it isn’t always as straight forward as it appears. Plus I tell the Client what underlying documentation for the insolvency worksheet he or she needs to have if audited. Most cancelled debt Clients think using Form 982 raises IRS red flags. But maybe 100 million (yes that’s right) got issued in the Recession and I think the IRS now regards a 1099-C tax return as ordinary, if that’s the right word. So the risk of an IRS audit is small. I’ve never had an IRS audit on any cancelled debt return but I’m sure it will happen eventually. So we try to bullet proof the return with supplemental explanation and documentation.
IRS tax Form 982, Reduction of Tax Attributes
Form 982 is a typical IRS Form. It’s used for multiple circumstances. It has significant consequences. It requires sub-schedules. Verbiage in the Form 982 instructions intimidates some Folks. But it’s the only way to prevent debt forgiveness from becoming taxable income. The Form 1099-C instructions aren’t even written for the taxpayer.
My advice is to relax before preparing Form 982. Hard to do sometimes.
What is Cancelled Debt?
Publication 4681 defines cancelled debt but here are some typical examples;
- You negotiate your credit card debt, getting the company to accept $4,000 to settle $10,000 balance. That “forgiven” $6,000 is cancelled debt, reported on Form 1099-C, and gets automatically included on Line 21 of Form 1040 as taxable income.
- You have a short sale on your home and the mortgage company “forgives” the remaining mortgage amount of $6,000. That “forgiven” $6,000 is cancelled debt, reported on Form 1099-C and generally included on Line 21 of Form 1040 as taxable income.
- You had a loan modification, typically on a home or rental property. The bank adjusts off some or all of a second mortgage. That adjusted amount is debt cancellation.
- You a car loan of $15,000 and stopped making payments. The bank repo(s) the car, sells it for $5,000 and forgives the $10,000 ($15,000 – $5000). The $10,000 becomes cancelled debt.
We deal with S Corporation and Partnership cancelled debt too, but don’t cover it in this post.
What is Form 1099-C, Cancellation of Debt?
The lender, in the above examples, reports the cancelled debt to both you and the IRS on Form 1099-C. The Form 1099-C lists:
- Your name.
- Your Social Security number.
- Amount of debt discharged, the infamous Box 2.
- Was debtor personally liable for repayment of the debt?
- The lender’s information.
- For secured debt, like a car loan or rental property mortgage, Form 1099-C may list the Fair Market Value of the secured property. The FMV is the most frequent figure I battle on Form 1099-C.
“Insolvency immediately before the debt cancellation is one of the IRS exclusions on Form 982.”
– Gary Bode, Insolvency CPA
Form 1099-C Tips:
- Don’t panic over a Form 1099-C, Cancellation of Debt. The IRS offers generous leeway on Form 982, Reduction of Tax Attributes, to keep cancellation of debt from becoming taxable income. So you navigate through the IRS tax reporting rules often to find there’s no additional tax due from the cancelled debt.
- Make sure it’s your Form 1099-C. A few clients got tagged for someone’s credit card debt write off. The bank refused to acknowledge this. We asked the IRS to help.
- Check the date of identifiable event that Form 1099-C shows for the cancelled debt. Some institutions use a default date of 12/31 which could limit your insolvency exclusion on Form 982, Reduction of Tax Attributes. Sometimes we can challenge the Form 1099-C date if that different date works better for the Client.
- Banks may still pursue you for the debt after they file Form 1099-C.
- It doesn’t seem to happen often and it’s always a mistake.
- One tax court case denied the bank’s right to collect on the debt once it issued Form 1099-C.
- Is the amount of debt discharged (cancelled debt correct)? A higher amount helps the bank increase its bad debt expense, but could result in you paying tax on some of the debt cancellation. The IRS thinks Form 1099-C, Cancellation of Debt, is Gospel. Generally you have to get the bank to issue a correct Form 1099-C.
- IRS Form 1099-A, Acquisition or Abandonment of Secured Property, is different from Form 1099-C, Cancellation of Debt. Form 1099-A doesn’t report cancellation of debt. The bank can still pursue you for the debt.
- The bank might cancel only part of the debt on Form 1099-C.
- Be aware of a potential 1099-C. Just because you didn’t receive a copy doesn’t mean the IRS didn’t. Call the bank or pull your IRS record of account.
- The IRS knows some taxpayers didn’t get their copy of 1099-C.
- I sometimes amend the prior tax return or provide the missing Form 982 in simpler cases.
- Even if don’t receive the 1099-C the IRS requires you to present it on your current tax return. So you have to infer it based on your best information.
- Doing so shows good faith but sometimes requires an IRS letter when the actual 1099-C arrives.
- The Form 1099-C can arrive years beyond the triggering event. The most extreme case I’ve heard as an insolvency CPA was where the caller stated the 2012 Form 1099-C identifiable event occurred in 1992. He said a friend worked at the bank that forgave the debt, and claimed the bank issued 30,000 2012 Form 1099-C(s) in March 2012 for cancellation of debt going back to the 1990(s).
- Statue of limitations exist at the State and IRS level.
- In general, the IRS doesn’t give up taxable income without due diligence. Bullet proof your return. We anticipate what a skeptical IRS Agent might want to see as corroborating evidence and provide it through supplemental information.
- If you can’t get the bank to correct an incorrect Form 1099-C you can make a case for your figures on the cancelled debt tax return.
- If you receive a Notice CP2000 proposing more tax on a Form 1099-C you didn’t receive, consider amending the return to include both the debt cancellation and form 982.
- I sometimes amend the prior tax return or provide the missing Form 982 in simpler cases.
The Reduction of Tax Attributes Facet of Cancellation of Debt and Form 982; future tax consequences
The IRS tries to ensure that Form 982 doesn’t actually eliminate future tax liability. Often you’re required to change the basis (purchase price) of your remaining assets. That can mean higher gains or lower losses when you sell those assets. So the IRS gets another shot at you in the future. Tax attributes is the least logical aspect of Form 982. One way to tell if you have a good insolvency CPA is if s/he asks about future tax consequences.
IRS Form 1099-C sometimes triggers an IRS reportable “sale”
Sometimes Form 1099-C does more than report cancellation of debt to the IRS. If you had a rental property short sale or foreclosure, you essentially sold the property, even though it might not have been voluntary. The bank provides a Fair Market Value of the property in Box 7 of Form 1099-C, Cancellation of Debt. Use Form 4797 to report the sale and calculate the gain or loss. You may have an ordinary loss on the property transaction that can offset ordinary income on Form 1040. Or, you can carry it forward to future tax returns. But the IRS gain/loss calculation takes a nasty turn because you have to adjust the tax attributes (cost) any remaining rental property. And you pay tax on any gain. Rental property calculation of gain or loss is more complex than a logical person might assume – LOL.
We’ve had a few Form 982 cases where the impetus was a Form 1099-S reporting a real estate sale to the IRS. In one case, when we pulled the IRS transcript, there was also a Form 1099-C lurking there as well. The client received neither Form 1099-C or Form 1099-S because they got issued two years after precipitating event and the realtor and bank had a bad address.
Things become more complicated if the cancelled debt is business related because insolvency factors in IRS “tax attributes”, which involves adjusting the basis of your remaining assets. As with many IRS issues, there are wrinkles within wrinkles. You can’t reasonably use this simple post as a basis for self tax preparation on a complex tax issue. At the very least you’ll need to do substantial research on info presented on IRS.gov, starting with Publication 4681. This is just a primer. We advocate self preparation of tax forms when it reasonable to do so. But insolvency / cancelled debt / Form 982 is an area where it might be unreasonable to self prepare your tax return.
If you’d like a free initial consult with an Insolvency CPA, please call us at (910) 399-2705.
Caution in using Insolvency and Form 982
Anytime you’re excluding Income from Taxable Income, it is probably a matter of interest to the IRS. Remember, cancelled debt is automatically Taxable Income unless you can use an exception or exclusion on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment). It is prudent to recognize that the IRS may scrutinize and then audit such a return. But again, per the above comments, that’s unlikely. We look for possible red flags, and if they’re legitimate, I try to explain them away on a supplemental schedule. And sometimes we include additional documentation as well. If you self prepare, think of Form 982 as a High School project with a grumpy teacher.