Beware of Form 1099C

by Richard S. Feinsilver on March 21, 2010

Are you using a debt management firm to settle your debts? Have you recently completed a short sale? Have you had a property foreclosed and the bank received less than the outstanding balance on the mortgage? If you have answered Yes to any of these questions, you should be on the look out for a 1099C from your creditors.

A 1099C forgiveness of debt is a statement that is issued to the IRS by a creditor in instances in which that creditor has not received payment in full of a debt. In essence, the foregiveness of debt can become ordinary income that you must declare in the year the debt was written off.

A creditor is required by law to issue a 1009C to any individual who settles a debt or has a debt written off that is in excess of $600.00. This is a very big trap that people with a large amount of debt may find themselves in. If you have received a 1099C in the mail, you may have to declare the amount stated on that form as ordinary income, and you will have to pay tax on it.

The 1099C is required to be issued by any creditor that settles a debt, or writes the debt off and the amount is over $600.00 For example, lets say that you settle a $25,000.00 credit card debt for $10,000.00. You will eventually receive a 1099C for $15,000.00 from your creditor.  You will be required to declare that amount as income on your tax return and you may end up paying tax on it.  This could, depending on your tax bracket, add up to an additional $5,000.00 to the cost of your so-called settlement.

There are two exceptions to the 1099C rule for most debt. The first applies when you are insolvent as the time the debt is written off. This is defined by the IRS. The second is if you file bankruptcy before the debt is written off and the 1099C is issued. In either of these events, there is no income to declare. Please note that if you file bankruptcy after the 1099C is issued, you may still have to declare that as income.

There is a third exception that has a limited impact on certain real estate trasnactions. It is the Mortgage Forgiveness Act of 2007. It applies to the homeowners of residential real estate only.  It also only applies to only to homeowners who had the debt written off during 2007 to 2012. The IRS website has examples to help you determine if you can qualify for this exception.

The issuance of Form 1099C and its consequences are often overlooked before making the decision to file bankruptcy. Its impact must be considered and may become the primary reason to choose the filing of a Chapter 7 bankruptcy or a Chapter 13 bankruptcy.

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