Q: Is it true that I will be given a 1099-c when I settle a debt for $600 or more off the amount that was due?
If so exactly what does this mean? What is the tax percentage I will be charged?
Is there a tax penalty fee for this? And will this increase my taxable income therefore putting me in a higher tax bracket?
A: Yes, it is true that you will be sent a 1099-C, Cancellation of Debt, when you settle a debt with a creditor and that creditor cancels or forgives a debt you owe of $600 or more.
This means that amount of debt “forgiven” during a settlement will be treated as gross income, and you will have to pay ordinary income taxes on that amount.
For instance, let’s say you had a debt due to a financial company or credit card issuer. The debt you owed was $3,000. However, you negotiated a settlement of $1,000 to be considered as payment in full of your debt.
In this case, you will pay $1,000, and the other $2,000 owed will be considered the amount of your debt that was “canceled” or “forgiven.” You will then get a 1099-C. Box 2 of the 1099-C will list $2,000.
That is the amount on which you’ll have to pay taxes.
There is no “penalty” per se on 1099 income. It’s merely that you have to pay ordinary income tax on this money.
The exact tax percentage depends on your own tax rate. As of 2010, the current tax rates in the U.S. are: 10%, 15%, 25%, 28%, 33% and 35%.
Also, depending on how much debt you have had forgiven and where your income falls, yes, it is possible that forgiven or canceled debt can push you into a higher tax bracket.
Check out IRS Publication 4681, Canceled Debts, for more information. Also, look at Topic 431 – Canceled Debt – Is It Taxable or Not? You can find both documents online at www.IRS.gov.