Old debts come back to life with 1099-C

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for CreditCards.com, and also wrote for MSN Money, Interest.com and Bankrate.com, and has guested on Martha Stewart Radio and other programs.

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Dear To Her Credit,
I received a Form 1099-C Cancellation of Debt notice in the amount of $683 from a debt I owed in 2006 to a bank. The bank filed a 1099-C with the IRS in 2011, but I didn't receive notice until I got a letter from the IRS in 2013.

From what I understand, there is a statute of limitations of three years for the financial institution to file with the IRS. But I cannot seem to find it in writing. I have contacted the financial institute several times, and they would not respond, so I had to file a complaint with the Consumer Federal Protection Bureau. When I finally did get a response, it was all bunk.

Because I never received a 1099-C in 2011, I cannot amend my taxes for that year. Seems the burden assessment is with the IRS. I knew nothing of this until last year. I cannot find anyone to assist me because of the amount being so little. As a last resort I could file insolvency for 2006 as I was unemployed. How do you file insolvency?  -- Carie


Dear Carie,
Here's the timeline for your debt:

  • 2006 - You owed the bank $683
  • 2011 - The bank filed a Form 1099-C to report cancellation of the debt to the IRS. You did not receive a copy.
  • 2013 - The IRS notifies you of $683 income from cancellation of debt for 2011.

The IRS requires banks to report the cancellation of debt when there is one of nine "identifiable events." These include a debt being discharged in bankruptcy; other federal or state court proceedings making a debt unenforceable; expiration of  the statute of limitations for collecting a debt, or for filing a claim or beginning a deficiency judgment; a negotiated settlement between creditor and debtor; discontinuation of the creditor's collection activity (based on a decision or as part of a defined policy) and certain other events.

The creditor could have used any of these events as a basis for reporting your cancellation of debt in 2011. As the debtor, you don't always know why they chose to report a debt in a certain year. It could have been the date they quit trying to collect, based on internal written collection policies. It doesn't really matter. You owed the debt and it's been canceled. Now it's between you and the IRS.

If the IRS has corrected your return for 2011, you should not file an amended return to report the income. The IRS has already made the correction and calculated the tax for you.

Here's what you should do, based on whether you were insolvent in 2011:

If you were insolvent in 2011:
You don't have to pay tax on the $683 of canceled debt in income if, as you say, you can show that you were insolvent. You must have been insolvent immediately before the debt was canceled, which is 2011 according to your Form 1099-C. To be insolvent means that your total debts were greater than your assets, including the fair market value of everything you own.

The IRS website provides a worksheet to help you determine if you were insolvent in 2011. 

Write the IRS a letter explaining that you were insolvent in 2011 and, therefore, should not include this income in your income.

If you were not insolvent in 2011:
You generally must pay tax on the $683 with your 2011 taxable income. Even so, the tax shouldn't be that high. If you're in the 15 percent tax bracket, for example, an additional $683 in taxable income will cost you around $100. The IRS will tack on interest expense, but fortunately the IRS interest rates for individuals are relatively low.

If the IRS adds a penalty in addition to the tax and interest, you should ask for "forbearance" of the penalty. Write the IRS a letter explaining that you did not receive the Form 1099-C. Ask specifically for forbearance of the penalty.

It sounds like this has been a long ordeal for you. The good news is that the debt is canceled, and the amount of tax you may have to pay the IRS is far lower than your original debt. It's time to put this behind you and concentrate on rebuilding your finances for the future. 

See related: 1099-C surprise: IRS tax follows canceled debt

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Updated: 01-23-2018