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. 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.
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 on Form 1099-C. Insolvency is one exclusion reported on Form 982. However we often use the insolvency exclusion with another provision on Form 982.
Update: Congress extended the discharge of qualified principal residence indebtedness for 2013 but that’s gone in 2014, making IRS insolvency even more important.
How much tax might you pay on cancellation of debt?
20-30% of the amount of Box 2 of Form 1099-C, Cancellation of Debt. Ouch.
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. Which seems straight forward, but becomes complex in most cases. The IRS provides some good examples in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abadonments.
Use the IRS Insolvency Worksheet to determine you amount of insolvency.
IRS tax Form 982, Reduction of Tax Attributes
Form 982 is a typical IRS Form. It’s used for multiple circumstances. It has signficant consequences. It has 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.
My advice is to relax before preparing Form 982. Hard to do sometimes.
What is Cancelled Debt?
- 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 generally 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 $6000. 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 $5000 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 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.
- Banks may still pursue you for the debt after they file Form 1099-C.
- It doesn’t seem to happen often.
- 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. But sometimes we build a case for a “better number” in Box 2 with the tax return.
- 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 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).
- 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 evidenceandprovide it through supplemental information.
- While you don’t submit the IRS Insolvency Worksheet with your tax return it’s best back that up with documentation when possible in case the IRS audits you.
- If you can’t get the bank to correct an incorrect Form 1099-C you can make a case for your figures on the 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.
The Reduction of Tax Attributes Facet of Cancellation of Debt and Form 982
The IRS tries to insure that Form 982 doesn’t actually eliminate 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.
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. Use Form 4797 to report the sale and calculate the gain or loss. You may have an ordianary 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. We look for possible red flags and then 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.
Here’s a link to comprehensive 982 tax preparation examples for personal cancelled credit card debt.