How Much Do You Pay on a 1099 for Settlement?

Settlement of a debt, such as a line of credit or a credit card, can allow you to end your obligation to make future debt payments without paying the full balance on your account. Lenders will sometimes accept a lump sump payment that is less than the account balance, particularly if you are behind on your payments and facing potential legal action for your debt. However, you may have to pay tax on debt amounts forgiven under a debt settlement.

1099-C Issuance

In most cases, after you have paid a reduced settlement amount to clear a debt under an agreement with a creditor, the creditor will send you a 1099-C form that shows the debt amount that was forgiven. The creditor must also send a copy of the 1099-C form to the Internal Revenue Service. The 1099-C form serves as evidence of the settlement for tax purposes.

Taxable Amount

When you settle a debt, the difference between the amount you owed at the time of settlement and the amount the creditor accepts as payment is taxable. The amount you pay under the settlement is nontaxable. For example, if you owe a creditor $12,000 in credit card debt, and the creditor accepts a lump sum payment of $8,000 under a settlement agreement, you will be responsible for paying tax on $4,000.

Taxable Rate

Amounts reported on a 1099-C form pursuant to a debt settlement are taxable at the standard rate for your income bracket. However, the forgiven amount listed on the 1099-C form increases your taxable income and may place you in a higher tax bracket. This means that you may be taxed at a higher rate than if you had not agreed to the debt settlement.

Exception

A creditor is not required to issue a 1099-C form to you or the Internal Revenue Service if the forgiven amount is less than $600. A debt settlement that forgives less than $600 will not increase your tax liability. For example, if you owe $2,500 in credit card debt and the creditor accepts a settlement of $2,000, the $500 you saved is not taxable. However, you must still include forgiven debt of less than $600 as miscellaneous income on your 1040 tax return form. Although you will list income amounts as an entry on the "Other Income" line on your 1040 form, you or your tax preparer will not count this entry when calculating your total taxable income.