Any Form 1099 reports various types of income of more than $600 from sources other than an employer. The 1099-C reports debt forgiveness as income. Commercial lenders must report any debt of $600 (or more) that they cancel or forgive to the Internal Revenue Service (IRS) as well as the borrower. Form 1099-C is the reporting tool.
Taxable Income
As soon as a lender dissolves the borrower's obligation to repay debt, the amount of that debt becomes income. Income from any worldwide source, earned or unearned, is subject to taxation in the United States. The cancellation of debt then becomes taxable income.
There are five principal exceptions to the taxable income rule. The exceptions include principal residence mortgage, bankruptcy, insolvency, farming activity debt and no-recourse loans. Form 982 allows the taxpayer to file the 1099-C as nontaxable income if the taxpayer attaches the 982 to the income tax return.
Form 1099-C
All 1099 forms must reach the intended recipient on (or before) Feb. 2. The amount of debt cancellation appears in box 2. If the amount is indeed taxable income, it must be included on the front page of your Form 1040 income tax return that you will file for the appropriate tax year.
In December 2007, Congress passed the Mortgage Forgiveness Debt Relief Act. Under this act, debt forgiveness resulting from modification of mortgage terms is reportable because a Form 1099-C went to the IRS and the borrower. However, it is not taxable if the borrower completes Form 982 and files it as part of the income tax return.
Debt Forgiveness: Student Loans
There are situations where the cancellation of debt applies to student loans. Student loans are long-term commitments. Loans issued by a government entity, a public benefit corporation or a school with programs that encourage service in underserved fields or populations are subject to forgiveness. An agreement to serve in an approved occupation for a specified period could result in the cancellation of student loan debt.
Student loan debt will cause a 1099-C to issue and the stated amount must show on your income tax return as taxable income for the year of cancellation. You can avoid this if you fulfill the terms of your loan agreement that requires you to work in a certain field for a specific amount of time. You must complete and file Form 982 with your income tax return.
Bankruptcy and Insolvency
Insolvency is the reason for many bankruptcy filings. This is when the value of assets is less than the total of your debts. When a Title 11 bankruptcy discharges these debts, a 1099-C will issue as a declaration of taxable income. You can complete Form 982 and attach it to your income tax return.
Document the insolvency issue on Form 982 in Section 1082. The amount you wish to exclude from income can be either the amount of debt forgiveness or the amount of insolvency, whichever is smaller.
Vehicle Repossession
Whether voluntary or involuntary, vehicle repossession results in taxable income. One exception involves the discharge of debt in a Title 11 Bankruptcy. Lenders try very hard to avoid negotiations that result in issuance of a 1099-C. They will hold you responsible for payment of any loss resulting from the sale of the vehicle at auction.
If you do obtain cancellation of this remainder debt under the provisions of Title 11, you will receive a 1099-C. Therefore, the remainder debt becomes taxable income. Form 982 will not exclude this debt from your income.
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