Insolvency CPAs see tax problems with clients who negotiated credit card debt cancellation. Based on my calls during late 2014, I expect the number of Form 1099-C(s) issued to increase during the 2015 tax preparation season. Some new clients don’t realize that cancelled credit card debt becomes taxable income. So I’ll touch on some main issues:
- Form 982 instructions.
- Dealing with the credit card companies.
- S Corporation cancelled debt.
- Tax problems arising from cancelled debt, including federal tax forms 1099-C, Cancellation of Debt, and 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).
- Cash flow planning.
- Cancelled debt strategies.
Form 982 instructions
The IRS instructions for Form 982 can be too sparse and too broad – go figure. The last page of Form 982 instructions show the IRS estimated time required for completion. That gives you an idea of the tax reporting requirements for cancelled debt. I used to think the IRS instructions were intentionally vague. But now I think the Form 982 instructions are the best that can be done. But note most insolvency CPAs use subscription databases instead of the Form 982 instructions. I read them every year and the IRS terminology, coupled with an odd technical writing style, make the Form 982 instructions hard to read, even for an insolvency CPA.
For example, many issues with rental property foreclosures aren’t covered in the IRS instructions for Form 982. You’d need to file Form 4797. The Form 4797 instructions don’t cover prior disallowed passive losses. You need the Form 8582 instructions for that. You’d need to understand depreciation recapture. Things get complex quickly.
Dealing with Credit Card Companies
I don’t deal with credit card companies unless there’s a tax issue involved. See the cancelled credit debt tax strategy section below.
Here’s few issues cancelled credit card debt clients have shared with me over the years.
- Stop paying the credit card companies. It can take several months of non-payment for them to get serious about negotiating.
- Prepare for months of disheartening phone calls. These include threats to sue.
- Continually mention you can’t pay.
- Document every contact.
- Some credit card negotiators say never admit the debt is yours.
- Offer a cash settlement if possible, usually at the end of the fourth or fifth month.
- Never give them additional information.
- Mention potential bankruptcy. Do your homework on what that means to the credit card company. If they’ll get $10,000 through bankruptcy, an offer of $18,000 now seems attractive.
S Corporation cancelled debt
Tax reporting requirements for cancelled debt on Form 1099-C vary and depend on what type of entity the cancelled credit card is for. Just as an example, S Corporation cancelled debt stays at the Corporate level and doesn’t flow in the shareholder Schedule K-1s. The Form 1120S instructions don’t even mention the line you report S Corporation on – go figure. So while my comments in this post mostly deal with the Form 982 instructions, most the issues occur in the Form 1120S instructions, Form 1065 instructions, etc. too.
Tax problems arising from cancelled debt including federal tax forms 1099-C, Cancellation of Debt, and 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)
Your credit score will plummet. You essentially have all the post settlement credit consequences as going bankrupt.
“Some folks don’t realize cancelled credit card debt incurs tax problems. I routinely amend prior tax returns for folks who paid full taxes on the amount listed in Box 2 of Form 1099-C.”
– Gary Bode, cancelled debt CPA tax accountant
Eventually you’ll receive federal tax Form 1099-C. The amount of cancelled credit card debt appears in Box 2. Check that number carefully. At this point you’ll owe tax on the amount in Box 2. I know that seems unfair. I ballpark the tax due at 25-30% of 1099-C’s Box 2. So $10,000 of debt cancellation can mean $2,500-3,000 of tax liability. Ouch.
The additional interest in Box 3 of Form 1099-C isn’t a factor unless you could have deducted it. I deal with business cancelled debt too and Box 3 factors in with those circumstances. Box 3would be an issue in S Corporation cancelled debt. But Box 3 is irrelevant to personal credit card debt.
But some of that cancelled credit card debt from Form 1099-C might be excluded from taxable income, by using federal tax Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment). The name alone scares folks. But the Insolvency provision of Form 982 is the only way to exclude cancelled credit card debt from taxable income. Insolvency for IRS purposes doesn’t mean bankruptcy.
The Form 1099-C date is crucial. The bank often defaults to 12/31, But if the credit card cancelled debt forgiveness occurred in 2/1 you might have less insolvency on 12/31. So I often challenge the 1099-C date. So that’s another example of the Form 982 instruction problems.
Cash Flow with Credit Card Cancellation of Debt
- Generally the credit card companies require a cash settlement. But I hear they might take that in installment payments.
- You’ll have an IRS tax problem that might require payment of 25-30% on the amount listed in 1099-Cs Box 2.
- Your insolvency CPA generally can exclude some or all the Form 1099-C cancelled credit card debt from becoming taxable income.
- You may have State taxes due from cancelled credit card debt.
Tax Strategy for Cancelled Credit Card Debt
Have as few assets as possible when finalizing the credit card cancelled debt settlement. Why? Being insolvent by the IRS definition can avoid cancelled credit card becoming taxable income on Form 982. Since you can control the Form 1099-C triggering event, you have some tax positioning strategies available. Folks engage me to help with that. No one wants to pay any tax they don’t have to. And it’s legal to manage your affairs to legitimately reduce and optimize your tax circumstances.
I’m an Insolvency CPA who deals with all types of cancelled debt from federal tax Form 1099-C and Form 982. If you’re intimidated by the Form 982 instructions, and don’t have a local insolvency CPA well versed in cancelled debt consider calling me for a free consult at (910) 399-2705. The CPA license is national and our virtual office makes distance irrelevant. (910) 399 2705.
Here’s a link that might help.
- specific Form 982 example for cancelled credit card debt.