Virtually all forgiven debt is considered as income by the IRS, which creates a nasty surprise for many taxpayers. I have had many clients come to me because they were surprised to learn they had an IRS debt, even though they had always filed their tax returns and paid the taxes that were due. This nasty surprise came about because someone had forgiven a debt and reported that forgiveness to the IRS on a form 1099. Unknown to the taxpayer, this is treated as income. The IRS then computes the tax due on that income, which of course, was never paid.
There are exceptions to this rule:
1). If you can prove the debt was discharged in bankruptcy or you were in solvent when the debt was forgiven, then it should not be treated as income to you and not taxable by the IRS. Another exception to this rule is, when a mortgage on your primary residence is cancelled, that forgiven debt should not be treated as income. Likewise, it should not be taxable.
2). If you are concerned that a forgiven debt might be treated as income, the first signal for you to consider is the form 1099-C. This is a key form which relates specifically to cancellation of debt. It would be issued by the creditor to you, with a copy to the IRS. If you have not received such a form, it maybe that this particular creditor did not (intentionally or unintentionally) decide to notify the IRS of the forgiveness of your debt.
3). To put this in perspective, the IRS anticipates that creditors will send taxpayers well over 6 million 1099-Cs’. This is more than double the amount that were issued in 2010.
One reason for the increase number of 1099-Cs’ is obvious because of the bad economy. However, another reason is the fact that at the end of 2012, the provisions of tax exemption for cancellation of mortgage debt on primary residences expires under the Mortgage Forgiveness Debt Release Act. The law basically allowed taxpayers to refinance their home and modify their mortgages without being subjected to the tax for debt forgiveness. However, the provisions of the Act, which allow for this exception expires the end of 2012.
If you have questions about any of these provisions call our office at