Forgiven Debt and Its Tax Implications
You’ve finally cleared up all your financial problems. You have stopped those pesky debt collection calls and have settled past obligations. Or so you think. Unless you have fully examined the rules surrounding the debt forgiveness you received, you may be responsible for serious taxes on that debt.
How can that be? Well, the answer is pretty simple. Let’s say you had a credit card that you never paid on and did not resolve through bankruptcy. The credit card company made every attempt to collect from you until you or a company you hired settled the debt, partially or in full. In other words, they released you from liability. So how could you owe taxes?
If you spent the money and did not pay it back, the IRS will consider that debt untaxed income. If the balance on the credit card was $3,000 at the time of the forgiveness, you had acquired things, purchased items, gone to dinner or taken vacations with those $3,000. You spent it as if it was income you had earned, and yet you never paid taxes on it. Therefore, the IRS makes you liable for that amount. The creditor will send you a 1099-C for canceled debt, which represents the amount forgiven.
Other situations that could cause you to receive a 1099-C include certain instances of mortgage, home equity, business and joint debt. But, these situations are unique and require examination by a debt lawyer to determine if they are subject to taxes.
When is Debt Forgiveness Not Taxable?
It would be wonderful if all forgiven debt was done and gone forever. But in reality, the IRS considers only certain forgiven debt non-taxable. Here are some debt forgiveness situations that will most likely result in a non-taxable event to the consumer:
• Mortgage debt forgiven between 2007 and 2012. The Mortgage Forgiveness Debt Relief Act of 2007 allows most mortgage debt forgiven as a result of the housing bubble to be considered non-taxable.
• Home equity loans forgiven during the same period may be considered non-taxable as long as they were used to make improvements to a primary residence and not for debt consolidation or other purposes.
• Bankruptcy can create non-taxable debt forgiveness for debt that otherwise would be taxed. Credit card forgiveness, car loan debt forgiveness and other types of loans usually considered taxable by the IRS if forgiven may be spared from taxes if they are included in a consumer or business bankruptcy.
What To Do If Faced with Debt Forgiveness Taxes
There are many debt relief options available to consumers, however they do not all apply to every type of debt. It is important to work with a debt relief attorney to understand if and when taxes apply to debt forgiveness. Also, even the IRS makes mistakes and they have been known to try to collect more tax than is legitimately owed on a debt. This can be especially difficult to resolve without the help of a legal professional such as debt relief lawyer.
If you had a debt partially or fully forgiven and are unsure whether or not you owe taxes on the debt, do some research on what type of debt you had and if it falls under any of the laws designed to help consumers with debt forgiveness taxes. If you do owe taxes or have been contacted by the IRS regarding a 1099-C, begin to devise a plan to pay those taxes. If you do not believe you owe taxes, work with a debt relief attorney who specializes in debt settlement to determine exactly what you do and do not owe and if there is a way to avoid being taxed on forgiven debt.
Getting out from under debt can be a difficult process. The last thing you want is to find out you owe taxes on a debt, just when you thought the debt nightmare was finally behind you. Don’t assume you are in the clear. Review your financial situation with a debt settlement attorney and go over every debt with a fine toothcomb to ensure you have fulfilled every obligation required by your creditors and the IRS. Going forward, avoid getting in unnecessary debt. This will help you make better financial decisions and keep you free from debt.