Form 1099-C is used to report cancellation of debt if the cancelled debt amount is $600 or more. The lender is required to file form 1099-C to the IRS to report the details of the cancellation, and send a copy of it to the debtor. The debtor after receiving 1099-C is required to report and pay taxes on the canceled debt it because a cancelled debt is considered taxable income for tax purposes.
Cancelled Debt and Taxes
If a debt is cancelled, forgiven or discharged, the borrower is required to pay taxes on the amount of debt cancelled. It might seem unfair to pay taxes on a cancelled debt, but the fact is that when the borrower borrows money, he/she is not required to pay taxes on the amount borrowed. That is because they are under a contract to eventually repay it. However, when the borrowed money is not to be repaid (fully or partially), the IRS considers it income, and therefore, charges tax on it.
As taxpayers receive 1099-C from the creditor and not the IRS, they often misunderstand its importance. A 1099-C reports the amount of cancelled debt and includes the following information:
- The creditor’s name, address and telephone number
- The debtor’s name, address, and account number
- Amount of debt discharged
- Interest if accrued
- Date of identifiable event
- Debt description
- Fair market value of property
This form acts as proof of the cancelled debt by the creditor. When reporting and paying taxes on the cancelled debt to the IRS, the debtor will use information from Form 1099-C. Taxpayers receive 1099-C for canceled debts, including credit card debts, foreclosure, and repossession.
If you qualify for an exclusion or exception, you may not be required to pay taxes on the canceled debt. Insolvency exclusion is one of the most common exclusions. In insolvency exclusion, the forgiven debt qualifies for exclusion if:
- The total liabilities of the borrower are more than the total assets, or
- The debt is discharged under a Title 11 bankruptcy proceeding such as Chapter 7 or Chapter 13, or
- The debt is qualified farm indebtedness or a qualified real property business indebtedness.
If you do not qualify for an exclusion or exemption, you are required to pay taxes on the canceled debt amount if it is $600 or more. Non-payment of taxes on canceled debt attracts the same penalties and interest as that on income tax.