Cancelled Debt Tax Reporting for Student Loans | Form 982 CPA explains how to handle IRS Form 1099-C, Cancellation of Debt

Cancelled debt tax reporting for student loans generally uses the Insolvency provision of Form 982, Reduction of Tax Attributes. This post deals with how to battle a Form 1099-C, Cancellation of Debt, for student loan debt. I’ll try to cover the most common student loan cancelled debt questions I hear as a Form 982 CPA, whether through our free consult offer or comments on our website. But, some background first.

Emotional aspects of cancelled debt tax reporting

• I’m not a Psychologist, but cancelled debt seems to cause more anxiety than any other type of tax reporting. The Client has been through financial hard times and Form 1099-C just opens up that wound again.
• The IRS Form 982 instructions and Publication 4681 cover the entire scope of cancelled debt tax reporting making self-preparation intimidating.
• There’s a lot of potential tax liability increasing anxiety.

What is Cancelled Debt?

Cancelled debt occurs when a lender writes off some or all the money you owe to them. Typical scenarios that generate debt cancellation include:

• Student Loan cancelled debt. Sometimes called student loan forgiveness.
• Cancelled credit card debt.
• Cancelled student loan debt.
• Car repossession.
• Foreclosure on your home.
• Short Sale of your home.
• Loan modification for your home mortgage.
• Foreclosure on your rental real estate property.
• Short Sale of your rental real estate property.
• Loan modification for your rental real estate mortgage.

Sometimes your student loan cancelled debt is an “exception” and incurs no tax. So research that first using IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. But in my experience, once you receive a Form 1099-C for student loan debt cancellation, the amount in Box 2 is taxable unless you can exclude by using Form 982, Reduction of Tax Attributes.

The typical IRS tax forms involved with canceled debt tax reporting:

• IRS Form 1099-C, Cancellation of Debt. The lender sends Form 1099-C to you and the IRS. The amount in Box 2 of Form 1099-C becomes taxable income unless you exclude it through use of Form 982. 5.3 million Form 1099-C(s) got issued for 2012. Since Form 1099-C is often late, there could easily be another 250,000 2012 Form 1099-Cs for 2012 issued for 2013. I regularly amend earlier tax returns to include a late arriving Form 1099-C, Cancellation of Debt, and Form 982, Reduction of Tax Attributes.
• IRS Form 982, Reduction of Tax Attributes. Form 982 offers multiple exceptions and exclusions for preventing Box 2 of Form 1099-C from becoming cancelled debt income on Line 21 of Form 1040. Some of the Form 982 provisions are:
  • Bankruptcy.
  • Insolvency.
    • Student loan cancelled debt usually uses the Insolvency provision.
  • Exclusion for Qualified Principal Residence Debt.
  • Exclusion for Qualified Real Property Business Debt.
  • Exclusion for Qualified Farm Debt.
• IRS Form 1040.

Can Lenders still try to collect the cancelled debt once they issue Form 1099-C, Cancellation of Debt?

Yes. Sometimes. I know it seems unfair.

Form 982, Reduction of Tax Attributes

Form 982 presents the results of the IRS Insolvency Worksheets e.g. cancelled debt you can’t exclude on Form 982 for taxable income. The tax reporting rules for cancelled debt depend on what provision you’re using on Form 982.

Here’s good post providing comprehensive examples of how to handle student loan cancelled debt.

Exclusion of cancelled debt through Form 982 isn’t always a free ride. Sometimes it just delays IRS tax liability until you sell one of your assets. There’s some tax positioning possible for cancelled debt tax reporting, but it takes time to set up.

“Never pay tax on student loan cancelled debt without rigorously exploiting Form 982.”
- Gary Bode, Form 982 CPA

Is Form 982 an IRS red flag?

Well I think the IRS never likes to give up taxable income without a fight. Plus there’s undoubtedly a high percentage of self prepared tax reporting that’s inaccurate. But with the millions of Form 1099-C generated it seems unlikely the IRS has enough resources to audit many Form 982 tax returns.

As a Form 982 CPA, I present tax documentation and explanations when I feel it necessary.

Amending your prior tax returns for a late Form 1099-C, Cancellation of Debt

I routinely amend prior tax returns when a Client receives a late Form 1099-C. But often it’s an IRS Notice CP2000 that prompts a call to me. Many folks don’t receive the Form 1099-C. But they don’t look for it either. Notice CP2000 proposes tax on the entire amount of cancelled debt in Box 2 of a Form 1099-C the client never received.

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