If someone you owe cancels or forgives your debt then it can feel like a huge win, but under US law the IRS still owns a piece of that pie and wants to keep track of it whether you pay or not.
Here, we’ll explain all you need to know about taxes related to cancelled or forgiven debt.
When do you need to tell IRS about a debt?
As the debtor, if you do have a debt cancelled or forgiven then the lender must send on a 1099-C to turn that cancelled debt into taxable income.
This only applies if the debt is over 600 dollars, if you as the debtor are an applicable financial entity and if an ‘identifiable event’ occurred – so most cases if there’s a medium-to-large scale debt.
An identifiable event includes bankruptcy, defaulting on the loan, an extinguishment or cancellation that leaves the debt unenforceable or a cancellation upon the expiration of the statue of limitations for collection of indebtedness.
How do you file a 1099-C?
The ball is in the lender’s court on this one, so they have to do the early legwork. The 1099-C has three parts, Copy A, Copy B and Copy C.
However, you should’ve received a 1099-C form due to a cancelled debt. If you didn’t, it’s your responsibility to contact the creditor.
The lender fills out Copy A, the debtor fills out Copy B and the lender keeps Copy C as record.
You should receive the form by January 31 the year after the debt was cancelled or forgiven, and they’ll have already filled out Copy A so read that through and ensure it’s correct. If not, contact the creditor and ask for a corrected form.
If you fail to file the form then you can receive a fine ranging from 50 dollars per form, if then filed correctly within 30 days, to 280 dollars per form, if filed after the first of August. The maximum penalty can reach nearly 3.5 million dollars.