What Does It Mean if You Get a 1099 Cancelled Debt?

A notice for a 1099 cancelled debt is a form for the Internal Revenue Service (IRS). Its formal name is Form 1099-C, Cancellation of Debt. Creditors and debt collectors issue the forms after settling debts with debtors for less than the full amount. They send a copy to the IRS.

Definition

The Federal Trade Commission (FTC) recognizes debt settlement as a legitimate debt-management solution. People who have fallen behind on unsecured debt such as credit cards often use debt settlement to pay off the accounts. Credit card companies and debt collectors often will accept 20 to 70 percent of the balance to settle delinquent accounts. That means a debtor possibly could settle a $1,000 credit card balance for just $200. That's a savings of $800. However, the IRS treats any savings of $600 or more as income, and requires creditors or debt collectors to send debtors a 1099 form.

Process

Debtors receiving 1099 forms must include the information on their federal income tax returns. The IRS requires debtors to report debt-settlement savings even if the creditor or debt collector does not send a form. People who settle debts could face a higher tax bill as a result, especially if they are negotiating high balances. For example, people settling multiple credit card accounts or judgments from automobile repossession may receive 1099 forms totaling thousands of dollars, and it's all treated by the IRS as extra income.

Considerations

There is no way to avoid reporting debt settlement unless the savings is less than $600 on a specific settlement. Creditors and debt collectors will not agree to withhold the information from the IRS, and taxpayers who fail to report the transactions could face tax penalties.

Strategy

Circumstances sometimes dictate when a debtor must settle a debt. For example, people facing court action for an unpaid debt may settle immediately rather than risk losing a lawsuit. However, people who can plan debt settlement should study the tax consequences before making payment. Debt settlement activity in December could lead to a higher tax bill four months later in April. But waiting until January gives the taxpayer until April of the following year -- 15 months -- to resolve tax issues stemming from the settlement. Debt collectors usually send 1099 forms in January. Taxpayers who have not received them by the end of January should contact debt collectors to request the form.