IRS tax Form 982 CPA tax accountant discusses Form 1099-C, Cancellation of Debt

As a Form 982 CPA I’ve talked with hundreds of Folks dealing with a Form 1099-C, Cancellation of Debt, so far in 2014. Probably thousands since the Recession. In addition, hundreds of comments on cancelled debt exist on this website. So I understand some of the issues Folks endure with the tax reporting of cancelled debt. I’ll deal with the most common Form 1099-C and Form 982, Reduction of Tax Attributes, misconceptions.

The Form 982 instructions are difficult to read

I have potential Clients telling me they feel stupid (for lack of a better word) because they can’t decipher the Form 982 instructions. You’re not stupid. Even cancelled debt CPAs often use third-party referencing services to break down IRS instructions.

The IRS Form 1099-C instructions

These are meant for the banks, not taxpayers. Some Folks say it took time to realize the instructions weren’t relevant.

Form 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments

Again, some Folks tell me they feel mentally challenged because Publication 4681, essentially the true Form 1099-C instructions, is a hard read. In all fairness to the IRS, Publication 4681 covers multiple topics and issues. Plus there are situations where you must read other IRS documents to augment Publication 4681.

Form 1099-A, Acquisition or Abandonment of Secured Property, isn’t a cancelled debt tax document

Form 1099-A reports a transfer of title for a secured asset. The secured asset is generally rental real estate property or a primary residence. Form 1099-A means you had a reportable transaction for the IRS. But the amount in Box 2 isn’t cancelled debt. Why am I making such a fuss? I’ve amended tax returns in 2014 because the tax preparer made the amount in Box 2 of Form 1099-A taxable. Ouch.

The Discharge of qualified principal residence indebtedness exclusion on Form 982, Reduction of Tax Attributes, is gone for 2014

Well that’s true, at least for now. I think there’s a chance it will be reinstated. The Senate Finance Committee moved in that direction. So you’re stuck using the discharge of indebtedness to the extent insolvent (not in a title 11 case) exclusion of Form 982. Discharge of indebtedness to the extent insolvent means insolvency. That’s a good example of the complex verbiage I described above.

Form 982 automatically makes the cancelled debt on tax Form 1099-C non-taxable

Nope. Form 982 generally reports the result of a calculation made on other IRS worksheets.

The Insolvency exclusion on Form 982 is an all or nothing situation

Nope.

• If you have no insolvency you can’t exclude any 1099-C cancelled debt from taxable income.
• If your insolvency is equal or greater than the debt cancellation in Box 2 of Form 1099-C, you can exclude all the cancelled debt.
• Every dollar of insolvency reduces the taxable income by one dollar.
  • If your 1099-C shows $100,000 of cancelled debt, and you have $60,000 of insolvency, you can exclude $60,000 from taxable income and pay tax on the other $40,000.

Your credit rating may affected by a Form 1099-C, Cancellation of Debt

That’s true. Not because of the Form 1099-C directly, but the underlying financial transaction often appears on your credit report.

Your State’s tax return automatically follows the federal tax reporting for Form 1099-C and cancelled debt

Not always. Discharge of qualified principal residence indebtedness exclusion on Form 982 wasn’t accepted in some States. So using Insolvency on the federal tax return might mean paying some more federal tax but may save on overall taxes when the State tax consequences are included.

Does Form 1099-C, Cancellation of Debt, mean the bank can’t collect?

Not always. Sometimes they try to.

“You can use multiple exclusions on Form 982. Some Folks assume you can only use one.”
- Gary Bode, Form 982 CPA tax accountant

Will a Form 1099-C be issued?

Yes, although it can be years later. The banks use Form 1099-C as documentation for bad debt expense on their tax returns. No lender gives that up.

I didn’t receive a Form 1099-C for 2014; do I wait for it?

Well my advice is to pull your 2014 IRS records, typically available after May. I’ve had many Clients who never received Form 1099-C and only became aware of it when the IRS sent a Notice CP2000. Often the bank issues the Form 1099-C in some future tax year. Why? The IRS allows the banks to use multiple triggers for issuance. But you’re required to report the cancelled debt even if there isn’t a Form 1099-C.

That can actually work for you. First filing to include the un-reported cancelled debt show good faith when the Form 1099-C gets issued. Second, especially with the insolvency exclusion of Form 982, your financial position generally improves once the debt gets cancelled. So an earlier date on Form 1099-C date might help.

How much tax is at stake?

A rough rule of thumb to estimate your potential tax due from cancelled debt? Multiple Box 2 by 25-30%. So $10,000 of cancelled debt means $2500-$3000 of additional tax unless you can exclude it thorough Form 982.

“Many Clients feel battered because their financial difficulty resulted in cancelled debt. You’re not alone. The IRS reportedly received 530 million, yes million, Form 1099-C(s) two years ago.”

My Form 1099-C, Cancellation of Debt, is wrong

Well the IRS assumes it’s right. And getting the bank to correct is difficult. Sometimes I’ll challenge the date on the Form 1099-C if that helps the Client. For example, let’s say you had a rental property short sale on July 1st, 2014. And part of your Form 982 exclusion uses insolvency. The bank issues the Form 1099-C in 2015. In 2015 you had no insolvency. But you did on July 1st, 2014. So typically I’ll send in the short sale agreement as documentation and request the IRS use the 2014 date.

Don’t use estimates for the Insolvency exclusion on Form 982

I haven’t had any of my cancelled debt / Form 982 tax returns audited, yet. But it seems reasonable the IRS would scrutinize any situation, including cancelled debt, where they’re losing taxable income. Round numbers are the hallmark of estimates.

What documentation do I need for Form 982?

It depends. But I like to have solid documentation for each “good” number on the cancelled debt portion of the tax return. So there’s often some legwork required to find documentation. Sometimes I include explanations and documentation with the tax return. Why? If something looks off but is legitimate an explanation might prevent additional IRS scrutiny.

Every CPA is a Form 1099-C CPA?

Well no. I never expected to specialize in cancelled debt tax reporting. But a national audience, and the Recession, made me a Form 982 CPA. Many brick and mortar CPAs, tax attorneys and enrolled agents don’t have enough cases to become proficient in cancelled debt and Form 982 tax reporting. No single tax preparer, including me, can be an expert on all the tax code. Just not possible. This week alone I’ve consulted for a tax attorney and two CPAs. Plus a CPA tax attorney became a client for his own cancelled debt tax return. That being said I’m sure there are countless experienced tax professionals out there, but my Clients typically state they can’t find one.

Do you need a Form 982 CPA tax accountant?

If you poke around my website you’ll see I advocate self preparation of tax returns when it’s prudent to do so. But cancelled debt and Form 982 get complex fast. There’s usually a lot of potential tax involved. I wouldn’t count on hitting one out of the park on your first experience with cancelled debt tax reporting.

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