Tax Form 1099-C CPA accountant answers Cancelled Debt FAQs including Insolvency on Form 982 (Reduction of Tax Attributes)

I’ve fielded over one thousand calls in response to our offer of a free phone consult on IRS tax Form 1099-C, Cancellation of Debt and IRS Form 982, Reduction of Tax Attributes. Dozens of these calls were from tax preparers including CPAs, Enrolled Agents and tax Attorneys. So I think there’s lots of confusion and conflicting information on the tax implications of IRS Form 1099-C and battling it with IRS Form 982. I’m presenting the most common cancelled debt issues I hear.

Our virtual office means I can help you or your company with cancelled debt issues wherever you’re located.

Sources of help for Form 982 and 2013 income tax return preparation:

• The Form 982 instructions.
• IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.
• Dozens of posts in this website.

What is an IRS tax Form 1099-C, Cancellation of Debt?

When a lender forgives any debt, the IRS requires them to report it on Form 1099-C. Copies of Form 1099-C go to you and the IRS. But there’s an exception to the general rule – please read below. Here’s a partial list of common scenarios resulting in a Form 1099-C:

• The bank forecloses on your home.
• The bank forgives some mortgage debt after a short sale of your home.
• The bank modifies your home’s first or second mortgage by cancelling some of the debt. One example is HELOC.
• You abandoned your home and the bank took possession.
• Your rental property got foreclosed.
• You had a rental property short sale.
• Student loan debt cancelled debt.
• Credit card cancelled debt.
• You went bankrupt.

Is my bank allowed to continue collection attempts once I receive Form 1099-C?

Generally no. But one of the events triggering a Form 1099-C is when you haven’t made any payments for the debt for three years. Here the bank may continue debt collection activities.

What is the debt cancellation process with Form 1099-C and Form 982?

The amount in Box 2 of Form 1099-C, Cancellation of Debt, generally becomes taxable income. But exceptions exist. Cancelled debt becomes taxable income unless you can exclude it using Form 982, Reduction of Tax Attributes.

How much income tax will I pay on the amount of cancelled debt in Box 2 of Form 1099-C?

Whatever cancelled debt income you can’t exclude through Form 982 gets taxed as ordinary income. Figure 20-30%. I’ve seen that initial potential tax bill top $100,000. Ouch.

What is Insolvency for cancelled debt on Form 982?

Form 982, Reduction of tax Attributes, has multiple provisions to exclude cancelled debt from Form 1099-C. Insolvency is just the best known conduit. All provisions of Form 982 have complex tax reporting requirements.

Can I use more than just one provision on Form 982, Reduction of Tax Attributes, to battle the cancelled debt income reported on Form 1099-C?

Yes. My guesstimate is that 5% or so of our cancelled debt tax preparation cases use multiple provisions of Form 982.

It seems unfair I must pay taxes on income I never had

After a devastating financial year (or two) the IRS delivers the last blow. I’ve had folks cry during the initial consult.

“Stress reduction alone might be enough reason for some Folks to hire a Form 1099-C CPA to prepare Form 982 and the underlying income tax return.”
- Gary Bode, Form 1099-C CPA accountant

Why did my bank wait so long to issue my Form 1099-C?

I’ve talked with cancelled debt folks who received their Form 1099-C five years after the precipitating incident. I’ve heard of cases going back over 10 years. Please see the next cancelled debt question.

Does my Form 1099-C Cancellation of Debt contain errors?

Sometimes yes. But the IRS thinks the Form 1099-C is Gospel. And of the course the banks seldom seem willing to correct Form 1099-C errors. Here’s a list:

• The debt isn’t yours. The solution? Try to get the bank to cancel the Form 1099-C. Document your attempts to remedy the incorrect Form 1099-C. Then file your income tax return with the Form 1099-C and build an airtight case about being the wrong person or business.
• The date on Form 1099-C, Cancellation of Debt, is wrong. The insolvency provision on Form 982, Reduction of Tax Attributes, is time sensitive. The bank sometimes uses a later date. You or your Company’s financial condition might have improved meaning you can exclude less taxable income on Form 982.
• The amount is wrong on Box 2. The bank’s own bad debt deduction for their tax return increases as the amount in Box 2 of Form 1099-C increases. You can battle this 1099-C error on your income tax return by providing proof through good documentation and explanation.
• Multiple parties receive Form 1099-Cs for the same transaction, all showing the full amount of cancelled debt in Box 2. When possible I like to handle all the folks involved. When that’s not possible I calculate your share of the cancelled debt and present good documentation and explanations with the tax return

I never received my Form 1099-C

I guesstimate about 3% of my new cancelled debt tax preparation cases include this issue. Most of these cases involved a change of address. The IRS will send you a Notice CP2000 proposing to tax the entire amount. Here you’d amend the prior tax return to include both Form 1099-C and Form 982. Ask for penalty abatement. If you’re expecting a Form 1099-C, and don’t receive it, call the bank or pull your IRS account records.

Are there tax positioning strategies available for Form 1099-C and Form 982?

Sometimes. I mentioned retroactively correcting Form 1099-C errors above. But sometimes Clients can delay Form 1099-C and that could be beneficial.

When do I need a Form 1099-C CPA for cancelled debt tax return preparation?

• Calculate the amount of potential tax due by multiplying it by 20-30%. If that figure high enough to cause financial distress?
• Does your tax preparation software handle Form 982?
• Are you confident enough about your tax return preparation after reading the Form 982 instructions?
• Are you stressed out because of financial implications or confusing information?
• The Reduction of Tax Attributes section of Form 982 seems to confuse most folks. Sometimes there no immediate consequences when it’s wrong. Because the reduction of tax attributes affect future return I expect to work with Folks who’ve received an IRS Notice about the altered basis of assets when they’re sold.

Here are a few links to other Form 1099-C and Form 982 posts:

• Form 1099-C battle strategies.
• Rental property cancelled debt.
• Principal residence cancelled debt.
• Cancelled debt Insolvency on Form 982.
• Form 982 and bankruptcy.
• Schedule E cancelled debt.
• Student loan cancelled debt.
• Credit card cancelled debt.
• HAMP cancelled debt.
• Using an amended tax return to include cancelled debt.
• Form 1099-C tips.

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