Tax Impact of a Defaulted Forgiven Debt

If you are feeling overwhelmed by debt, you may be considering enlisting a debt cancellation company's help. That's one option you have instead of bankruptcy. However, if you are expecting your debt forgiveness company to arrange for you to pay only a portion of the total debt owed, be aware that there may be some consequences for your taxes.

Debt Cancellation

Debt cancellation is the process of working with a third party to pay off your debts, but only a fraction of the total amount owed. For example, if you have a credit card with a balance of $5,000 and you can't pay it, you might be able to get the debt cancelled if you pay one lump sum in an agreed upon amount. The amount you have to pay can vary but normally is a percentage of the total, such as 40 percent. When you do this, the credit card or loan company that holds the debt claims it as a loss on its taxes. Debt forgiveness does not affect your taxes when it is a mortgage or IRS tax debt -- you still owe the tax on the whole owed sum. Consult the IRS website to see what other debts you do not have to claim on your taxes when they are forgiven.

Your Taxes

When you settle a loan through a forgiveness program, you are more than likely going to have to claim the forgiven amount on your taxes. The government sees the forgiven amount as income. After paying off the debt, you should receive a 1099-C. The credit company will issue a 1099-C for any debt forgiveness greater than $600. Keep this with your tax information for when you prepare your taxes.

1040

It is important to report forgiven debt on your tax return. You'll find a place on your 1040 tax return where to record your forgive debt. The number of the line that it's on may vary from year to year, but the line where you're supposed to put the 1099-C information will be somewhere on the first page under the "other income" section. Do not include this amount in your regular wages.

Consequences

When you do not include any debt forgiveness information from 1099-C on your tax return, it will catch up with you later. It could result in a lower refund the following tax year, or you might have to pay additional taxes to make up the difference.