Under certain circumstances, a creditor who forgives a legitimate debt must issue a 1099-C documenting the forgiven debt. In many cases, the IRS counts this forgiven debt as income to the debtor, which will create a tax obligation. If you have forgiven debt or are negotiating a debt settlement, it is important to understand the creditor's requirements for issuing the 1099-C and how to deal with the form when you receive it.
1099-C Requirement
The IRS requires any creditor who forgives debt in excess of $600 to issue a 1099-C to the debtor as well as the IRS. The $600 limit applies only to the loan principal (the amount you borrowed) and not to other charges such as interest and fees. The creditor must send the 1099-C to both the debtor and the IRS by the end of the tax year in which the creditor forgave the debt. Even if the creditor fails to send you a 1099-C, the IRS still requires you to report the forgiven debt.
Reporting Forgiven Debt
If you receive a forgiveness of debt, you must report it on your tax form. In most circumstances, you will enter the forgiven debt on line 21 of Form 1040 or Form 1040NR. You will report the forgiven debt on different forms if you are a sole proprietor and the debt is from your business (Form 1040, Schedule C or C-EZ), is from rental property (Form 1040, Schedule E), is from farm rental activity (Form 4835) or if you are a farmer and the forgiven debt is farm debt (Form 1040, Schedule F).
Mortgage Debt
If you receive forgiven debt due to a mortgage, the IRS may not count the amount of the debt as income. The Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude up to $1 million ($2 million, if married filing jointly) of forgiven debt related to your principal residence. This exclusion covers forgiven debt from foreclosure as well as a mortgage restructuring during the 2007 through 2012 tax years. To qualify, you must have used the debt to purchase, build or improve the home and you must have used the home as collateral for the loan. While you do not have to report the forgiven debt as income, you must still note the forgiven debt on Form 982.
Other Exclusions
In addition to the mortgage exclusions, there are other situations where you do not have to report the forgiven debt. Debt cancelled as a result of chapter 7, 11 or 13 bankruptcy does not count as income. If you are insolvent, any forgiven debt in excess of the amount of your insolvency will not count as income. For example, if you owe $100,000 in debt and have $10,000 in assets, you are insolvent by $90,000. Any debt forgiven up to $90,000 will not create income. Other exclusions apply for forgiven farm and business debts. Even if you qualify for an exclusion, you must report the debt on Form 982.
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