Where Do Creditors List 1099-C Cancellation of Debt?

Debt settlement allows payment of delinquent debt for less than the current balance. The savings for debtors are often significant, with SmartMoney reporting that unsecured debts such as credit cards are often settled for 20 to 70 percent of the balance. However, the Internal Revenue Service may treat the savings as income, resulting in a higher tax bill. Creditors must report cancellation of debt to the debtor and the IRS. Creditors list the amount of debt forgiven, or cancelled, in box 2 of IRS Form 1099-C, Cancellation of Debt.

Timeline

The IRS requires creditors to mail 1099-C forms to taxpayers in January of each year. Forms are necessary for cancellation of debt resulting in savings of $600 or more. Possible tax implications are important. For example, someone settling a $10,000 debt for $3,000 would receive a 1099-C form showing debt cancellation of $7,000. In most situations, the taxpayer would list the $7,000 on his federal tax return as additional income.

Exceptions

Not everyone pays additional taxes because of debt settlement. The IRS allows exceptions for people who were financially insolvent at the time of the settlement. Insolvency means a person has more debt than assets. People who do not own real estate but have lots of debt may easily qualify for an exception.

Considerations

People who use debt settlement firms to settle debts may find the process much more costly than they thought. Debt settlement firms charge a fee for their services, meaning that in some situations the taxpayer must pay a fee to the debt settlement company -- and higher income taxes. Self-directed debt settlement eliminates the need for a settlement company.

Strategy

Possible tax implications require careful planning for debt management. Timing of settlement is important for people who cannot claim insolvency. For example, a debtor should avoid settling a debt in December. A debt settled then may result in a higher tax bill due only four months later in April. Waiting until January to settle gives the taxpayer 15 months to prepare for tax implications. Also, the IRS reports that taxpayers must report cancellation of debt even if the creditor fails to send the taxpayer a form 1099-C. Failing to report cancellation of debt could result in penalties. People who know that they cancelled debt should contact the creditor if they have not received a 1099-C by February.