Ines Zemelman, EA 15-Sep-16
Ines Zemelman, EASep-15-2016
There is most likely a tax form tower sitting on the desk, or probably just thrown on your kitchen counter - forms from banks, lenders, employers, stockbrokers, and many others. For some people, the forms will just be handed over to your tax preparer; for others, you will take the information from the forms and input it into your favorite tax software - perhaps even uttering a few four-letter words as you go. Regardless of how you intend to complete your taxes, you probably don’t know all the details about what the many letters, numbers, and other data printed on the forms mean. This is one of several posts that will change that, and help you start to understand the multitude of tax forms.
Form 1099-C, Cancellation of Debt
Form 1099-C, Cancellation of Debt, will be sent when at least USD 600 of debt is forgiven in an amount less that what you owe after the occurrence of an “identifiable event”. Note that you must still claim discharged debt as income on your tax return, even though it may be under the USD 600 threshold. Identifiable events are determined in the judgement of the creditor, but usually happen when they believe you will not be able to pay the debt, or if they have been unable to recover the debt from you. This often results from a repossession, foreclosure, voluntary transfer, abandonment, or a modification to a mortgage.
If a debt is canceled for an amount less than what is owed, the difference is treated as income and might be taxable. There are some exclusions and exceptions, though.
Even if an exclusion or exception applies, you might still get a copy of Form 1099-C. The creditor does not know your particular tax circumstances, so they don’t know if you qualify for an exclusion or exception. They are simply required to report information, including the date and amount of the cancelled debt. But, if the issuer of the 1099-C knows that the income is not reportable, they won’t issue the 1099-C. This could happen, for example, in the case of a gift or a bankruptcy.
You generally must report debt cancellation as income, although exclusions do apply. The most frequent exclusions are qualified principal residence indebtedness, insolvency, and bankruptcy:
- If the debt was forgiven under the bankruptcy code (Title 11, Chapter 7, Chapter 11, or Chapter 13), it is not included in income. For reporting, you will attach the Form 982 to the tax return & also tick the box in Line 1a, Part I of the tax form. The debt amount that was canceled due to the bankruptcy is entered at Line 2. It may also be necessary to complete Part II on the form.
- You are allowed to exclude debt from your income if you were considered insolvent just prior to your debt being canceled. The IRS has an insolvency worksheet so that you can calculate whether this provision applies. Usually, you are considered insolvent if your total liabilities were more than your total assets just prior to the debt cancellation. This exclusion is reported on Form 982, which gets attached to the tax return. Also tick the box in Line 1b, Part I of the tax form. The worksheet will help you calculate the exclusion amount, which will be either the debt amount that was canceled, or, if it is smaller, the amount the taxpayer was insolvent by just prior to the debt cancellation. You might also need to complete Part II on the form.
- Your debt is not includible as income if the debt that was canceled is qualified principal residence indebtedness. This means mortgages that were taken out to build, buy, or improve the main home (where you live the majority of your time) substantially. This mortgage has to use the main home as collateral, and the maximum exclusion is USD 2 million (or USD 1 million for married taxpayers filing separately). Like the other exclusions, use Form 982 to report it, and attach it to the tax return. Tick the box in Line 1e, Part I of the tax form. The amount that was forgiven is entered at Line 2, although it cannot be greater than the exclusion limitation. If you still own the home following cancellation of the debt, your cost basis must be reduced.
These exclusions are difficult to understand, so you might want to talk with a professional tax preparer.
Here is what a Form 1099-C usually looks like:
The Form 1099-A In More Detail
The left, top, side of the form has the payer’s information, and your information is on the left, lower side of Form 1099-C. Either your full Social Security Number (SSN), or perhaps only the last couple digits, is likely to be printed there as well. Although your full SSN is required for some other forms, such as the W-2, on the 1099-C the first few digits may be eliminated to help protect your privacy. Regardless of what is printed on the form, the lender sends your complete Social Security Number with Copy A when it is sent to the IRS.
Frequently, account numbers are optional for tax forms. But, on a 1099-C they are pretty common - lenders are encouraged by the IRS to enter them in the form. If you happen to have more than one account with the creditor who sent the Form 1099-C, you will see the account number on the form - if that is the case, they are required.
The date in Box 1 is when the lender determined that the identifiable event happened. For example, a foreclosure or receivership, a proceeding in a court, a short sale, a Title 11 bankruptcy, an agreement that the debtor does not need to pay the full amount, or a decision by the creditor to not continue to pursue collections.
Box 2 is the amount of debt still owed as of what is entered into Box 1.
The amount in Box 3 is the value of the interest forgiven. The creditor does not need to enter a value here unless they included interest in what was reported in the Box 2 amount. This is different than whether or not you must include the interest in the income reported on your tax return. This depends on if it would have been deductible if it had been paid (for example, a mortgage).
The entry in Box 4 shows a simple description of what debt is being discharged. This could be a mortgage, student loan, credit card, etc.
Box 5 will be checked if you were personally liable to pay back the debt. This is usually not true for mortgages since they are secured with collateral, but other loans, such as student loans, may require this box to be checked.
Box 6 contains a code that shows why you are getting the form. The codes and their descriptions are:
- Title 11 bankruptcy
- Other judicial debt relief (foreclosure, receivership, or similar state or federal court proceeding besides bankruptcy)
- Statute of limitations or expiration of deficiency period
- Foreclosure election
- Debt relief from probate or similar proceeding
- By agreement
- Decision or policy to discontinue collection
- Expiration of nonpayment testing period
- Other actual discharge before identifiable event
This code could affect whether or not you owe taxes on all or part of the debt, so it is important that it is right.
If you get a 1099-C with any of the information incorrect, contact your creditor so they can make the corrections. But, regardless of whether you receive a 1099-C with incorrect information, or even receive one at all, you are still responsible for reporting the correct taxable amount as income.
If property was abandoned or foreclosed in relation to the debt cancellation, the property’s fair market value (FMV) will either be in the Box 7 amount, or you may receive a Form 1099-A instead. But, if the lender cancels the debt, you shouldn’t get both a 1099-A along with a 1099-C - only a 1099-C should be sent. If you get both forms from a single lender (in regard to the identical property), the 1099-C should have Box 4, Box 5, and Box 7 empty.
For information on other relevant tax forms, look for other articles in this series.