Have you recently negotiated a settlement on your credit card debt? Did you know this debt cancellation may increase your income taxes exorbitantly?
There are vital financial details to consider if you have already negotiated a deal on your credit card debt or are considering it.
Last year, a client of mine decided to contact his credit card company and negotiate to have part of his debt cancelled. Then when he filed his taxes, he was dismayed to learn that, unbeknownst to him, he owed a huge tax on this debt.
The IRS designates the cancellation of debt as income and so in most cases it is liable for income tax. Just when it seems like it can't get any worse, people struggling to get out of debt are hit with another tax, but as the IRS sees it there are no free rides. You either pay off the debt that you incurred or you pay taxes on this “gift” from the creditors.
For example, if you owe $50,000 on credit cards and negotiate a deal to have 30,000 forgiven, leaving you with 20,000 to repay. Then this $30,000 is considered income on which you pay Income Tax.
What is the 1099-C Form?
The 1099-C is an important form that must not be ignored or discarded as there are major tax implications. If you have negotiated a deal to cancel a portion of your debt, then you are responsible to report this amount on your taxes. The creditor will send you a 1099-C, which is your copy of what the creditor has sent to the IRS and which you must include with your tax filings.
The 1099-C, Cancellation of Debt Form, reports the amount of debt canceled by the credit card company or the debt buyer. One copy is sent to the IRS and one copy is sent to you the recipient. When you negotiate the debt cancellation this amount is reported to the IRS and you are responsible for paying taxes on it.
What to do next? First, contact your tax advisor. Second, be prepared: start budgeting and saving for this additional tax burden immediately.
There are a few exceptions for debt forgiveness, such as if you have filed for bankruptcy, declared insolvency, or the debt forgiveness is related to the mortgage of your primary home, so check with a trusted tax advisor.
Check the Accuracy of the Amount of the Debt Reported
Make sure that the amount on the 1099-C matches with the actual amount of debt that was forgiven. There have been cases where the creditors or debt buyers add in administration fees and interest on top of the actual debt. If there are errors request that corrected forms be sent to you and the IRS.
Consult your tax accountant or for more information, click on this IRS Link, which includes detailed examples on Canceled Debts, Foreclosures, Repossessions, and Abandonments, found in Publication 4681. Also see IRS news release IR-2008-17.
IRS Statistics show the number of people filing for debt forgiveness has more than doubled since 2003 and is expected to continue to rise for at least another 2 years.
With the rise in debt and the curtailing of federal unemployment benefits, the time is now to get your numbers in alignment with your mission in life and start building for your dreams. Know your Numbers, Live Rich!