1099-C surprise: Canceled debt often taxable as income

By  |  Updated: January 25, 2017

1099-C surprise: Canceled debt often taxable as income


1099-C surprise: Canceled debt often taxable as income



If a debt is forgiven or canceled, the IRS requires lenders to issue a 1099-C tax form to the borrower to show the amount of debt not paid. The IRS then requires the borrower to report that amount on a tax return as income, and it’s often an unpleasant surprise:

If you thought your money woes ended last year when you settled that credit card debt, think again.

For many consumers with debt problems, after the debt collector leaves their lives, the taxman arrives.

Months after successfully resolving credit card debts, consumers may receive 1099-C “Cancellation of Debt” tax notices in the mail. Why? The IRS considers forgiven or canceled debt as income. Creditors and debt collectors that agree to accept at least $600 less than the original balance are required by law to file 1099-C forms with the IRS and to send debtors notices as well. The more than 6 million taxpayers a year who receive the forms must report that portion of forgiven debt as “income” on their federal income tax returns.

“A lot of people don’t realize they have any tax issues at all when they are going through this,” says Alison Flores, principal tax research analyst at H&R Block, the tax preparation service. “They say ‘I’m really poor, I’m broke and I can’t pay my bills. How can you consider this income?’”

It is, according to the Internal Revenue Code. For example, a person with $10,000 in credit card debt who negotiates to pay only $6,000 of the balance would have $4,000 in forgiven debt income. That $4,000 must be reported as “other income” on Line 21 of the 1040 tax form. Depending on the amount of debt forgiven, the taxpayer’s income level, deductions and other factors, the consumer could face a sizable tax bill come mid-April.

Surprise tax problem
The problem: Many consumers have no clue what 1099-C forms are, and some may trash cancellation of debt notices because the forms are sent by the same debt collectors with whom they thought they no longer had business. Still others are not filing the 1099-Cs with their federal income tax returns – putting taxpayers at risk for IRS audits, penalties and fines. Consumer credit counselors and tax attorneys say few consumers are aware of the tax implications of settling to pay a lesser amount than they owe in credit card debt.

In some cases it is the IRS that alerts people to the fact that they owe taxes on settled debt ... a very unpleasant surprise.

— Bruce McClary
National Foundation for Credit Counseling 

“In some cases it is the IRS that alerts people to the fact that they owe taxes on settled debt, but past the point where it would have been paid on time,” said Bruce McClary, spokesman for the National Foundation for Credit Counseling, a nationwide group of nonprofit credit counseling agencies. “A very unpleasant surprise for those who are unaware of or don’t receive their copy of the 1099-C.”

The number of surprise tax problems grew as the amount of bad debt shot up during the recession, and has lingered since.

According to the IRS, the number of 1099-C cancellation of debt forms filed with the federal government by creditors and debt collectors has seen a massive increase, including a huge surge after the recession. The IRS received fewer than 1 million forms in the calendar year 2003 and projects it will get 5.7 million in 2016.

IRS 1099-C tax form filings

The number of debt cancellation forms sent to taxpayers – and the Internal Revenue Service – shot up after the recession. It is projected to fall for the first time on 2016 forms, then resume its upward climb. The IRS estimates 5.7 million 1099-C forms will be filed covering the 2016 tax year, and 6.4 million in 2017. The agency predicts filings will hit 8.7 million in 2024.

Source: IRS Office of Research Publication 6961, September 2016 Update

Negotiating with creditors, debt collectors and debt buyers to pay a fraction of the amount owed is a common practice in the industry, often accomplished through third-party agents such as consumer credit counselors or debt settlement specialists.

“Debt buyers are willing to negotiate a discount, sometimes, depending on a person’s circumstances, at a very significant discount off the entire balance, to settle the debt,” says Donald Maurice, legal counsel for the 600-member DBA International, a trade group of companies that buy and sell portfolios of debt from banks and other creditors.

Not all forgiven debt taxable
Consumers who receive the 1099-C cancellation of debt forms should immediately take them to a tax preparer or tax adviser, experts say.

“Make sure your tax preparer understands the rules related to these type of activities,” says Mark Steber, chief tax officer for Jackson Hewitt tax preparation service. “Ask to talk to an office manager. Tell them ‘I need to see someone who understands this type of situation.’”

Taxpayers may qualify for one of several exclusions that allow them to reduce taxable income from canceled debts. If the exclusions apply, they must file an IRS form 982 in addition to the 1099-C.

The 6 exceptions to paying tax on forgiven debt include debts discharged during bankruptcy and debts of consumers who are insolvent (meaning their liabilities exceed their assets) before the cancellation of debt. However, the exclusion applies only up to the amount by which consumers are insolvent. That means if $5,000 in debts were forgiven and liabilities exceeded assets by $2,000, then the $2,000 would not be counted as taxable income. “The remaining $3,000 would be reported under other income,” says H&R Block’s Flores.


  • Consult a tax adviser before finalizing a debt settlement, and ask for a tax preparer who is knowledgeable about 1099-Cs.
  • Clarify with the creditor or debt collector the exact amount that will be declared on the 1099-C form.
  • Be aware that the 1099-C is coming. Don’t throw it away. Take it to your tax preparer.
  • If there is a dispute about the amount reported on the form, contact the creditor or debt collector immediately to resolve the matter. Ask for a corrected 1099-C form.

Homeowners exclusion ending?
Homeowners who default on mortgage loans on their primary residences may also qualify for an exclusion from income on foreclosures under the Mortgage Forgiveness Debt Relief Act, which took effect in 2007 to help homeowners caught in the mortgage crisis. This provision applies to up to $2 million in mortgage debt forgiven in calendar years 2007 through 2016. The exclusion had been extended before, and another extension through 2018 has been introduced in Congress.

Steven M. Piascik, a certified public accountant and president of PIASCIK in Glen Allen, Virginia, warns, “If you use the proceeds from a home equity line of credit to pay off credit card debts, or for something other than making improvements to your home, that portion will not qualify for the $2 million exception.”

However, if you used a credit card to pay for home improvements on your primary residence and can prove that the charges were exclusively for home improvements, you may be able to claim an exemption from mortgage-related debt forgiveness income for that card debt.

New for the 2016 tax year

  • The IRS exempted more students from taxes on discharged student loans that were used to attend certain private colleges. Those who borrowed to attend American Career Institutes Inc. (ACI) and whose federal student loans were discharged by the Education Department’s “Defense to Repayment” or “Closed School” discharge process are exempt from taxes on the discharged debt. About 4,400 borrowers may be eligible for the loan discharges, according to the IRS. The exemption follows one granted to students of Corinthian Colleges Inc. for tax year 2015.
  •  Fewer 1099-C forms should be issued for debts merely because they have gone 36 months without a repayment, reducing a big headache for taxpayers. The IRS in November 2016 published a bulletin canceling a previous rule that required creditors to issue 1099-C forms for debts that had gone without a payment for a 36 month “test period.”  Intended to account for debts that would likely never be repaid, the rule resulted in tax payments on debts that had not been forgiven at all, and were later the subject of debt collection action.

The 36-month reporting requirement had been cited as a major source of problems for taxpayers by the Taxpayer Advocate Service in its annual report to Congress. The requirement made it possible for creditors to issue a 1099-C form while continuing to collect a debt, or after selling it to debt buyers. “Creditors may threaten to ‘sic the U.S. government’ on a debtor by issuing  a Form 1099-C as a means of pressuring a debtor to pay,” the advocate’s report said.

Taxpayers who do receive a 1099-C form for a debt that has not been canceled as far as they know should contact the creditor for clarification. If the debt has not in fact been canceled, the creditor should rescind the 1099-C. If the creditor does not rescind the form, it will be necessary to use the IRS dispute process to show that the debt has not been canceled.

Informing consumers
Much of the surprise element of the 1099-C cancellation of debt forms could be eliminated, say tax preparers, if all creditors and debt buyers routinely informed consumers that there could be tax ramifications when settling debts for discounted amounts.

Says Maurice from the debt buyers group: “There is no current law that says that a debt buyer must disclose that a 1099-C would be forthcoming after the settlement of debt.”

The Taxpayer Advocate Service has cited confusion and inadequate communication about 1099-Cs in its annual report to Congress on IRS improvements needed to help consumers. The taxpayer advocate’s office has published YouTube videos in an effort to demystify the 982 tax form needed to claim an exemption from taxes on forgiven debt.

The bottom line on 1099-Cs is to be prepared for them, tax attorneys say. Don’t delay getting help from an expert if you need help determining whether you qualify for one of the exemptions. Ignoring the form can have dollars-and-cents consequences.

Steber, from Jackson Hewitt, warns that the IRS is more advanced at tracking taxpayers’ income. “There is an increased likelihood that if you had one of these events that the IRS knows about it,” he says. “The IRS tracks it back. The IRS is quick to catch up with the person who, for whatever reason, left that [1099-C] off of their return.”

Taxpayers who might have moved and didn’t receive their 1099-C notices in the mail from creditors can’t count on ignorance as a defense: “They will catch up with you,” Steber says.

See related: Beware growing tax fraud threat, Canceled debt exemption little used

Join the discussion
We encourage an active and insightful conversation among our users. Please help us keep our community civil and respectful. For your safety, do not disclose confidential or personal information such as bank account numbers or social security numbers. Anything you post may be disclosed, published, transmitted or reused.

If you are commenting using a Facebook account, your profile information may be displayed with your comment depending on your privacy settings. By leaving the 'Post to Facebook' box selected, your comment will be published to your Facebook profile in addition to the space below.

The editorial content on CreditCards.com is not sponsored by any bank or credit card issuer. The journalists in the editorial department are separate from the company's business operations. The comments posted below are not provided, reviewed or approved by any company mentioned in our editorial content. Additionally, any companies mentioned in the content do not assume responsibility to ensure that all posts and/or questions are answered.

Updated: 10-19-2017

Weekly newsletter
Get the latest news, advice, articles and tips delivered to your inbox. It's FREE.