If you enter a loan forgiveness program or a creditor cancels your debt after negotiating or modifying your total debts owed, you will receive Form 1099-C, Cancellation of Debt.
This form serves as a report to the IRS and unless you meet certain criteria, the cancelled debt will count as taxable income for that tax year.
You will receive this form when the canceled debt is $600 or greater; it is considered to be a gain because you never actually paid back the full debt owed.
You will be responsible for reporting all forgiven debts unless they were intended as a gift, or when your situation falls under one of the exclusions outlined below.
Defining a Canceled Debt
Many people are confused about whether their forgiven debt has actually been canceled and whether it is taxable or not.
The IRS explains that generally speaking, you are responsible for paying taxes on a debt that has been forgiven, discharged or canceled.
You will receive Form 1099-C from the creditor, and that 1099-C will include the total amount of debt that was forgiven.
You have to include this amount in your gross income unless you meet some type of exclusion or exception.
In cases where the creditor is still trying to collect the debt from you – whether this is in the form of phone calls, letters, or other means of communication – then the IRS would not consider this to be a taxable cancellation of debt income.
Examples of situations where a debt cancellation may occur include: a foreclosure; repossession of a vehicle or other asset; a voluntary return of property to a lender; abandoning a property; or a loan modification on a principal residence.
You would need to report the cancellation of these types of debt on your Form 1040 or Form 1040NR, regardless of whether or not you receive a Form 1099-C from the lender or creditor.
Exceptions and Exclusions for Reporting Canceled Debts
Under some circumstances, the IRS does exclude the reporting of certain types of canceled debts.
If any of the following apply to you, you will not be required to report the canceled debt as part of your gross income:
Any amounts excluded from income by law, such as gifts and bequests
A cancellation of certain types of qualified student loans
Canceled debt that if paid on a cash basis taxpayer is otherwise deductible
A qualified purchase price reduction granted by the seller
Cancellation of qualified principal residence indebtedness
Debt canceled in a Chapter 11 bankruptcy case
Debt canceled while you were deemed insolvent
Cancellation of a qualified farm indebtedness
Cancellation of qualified real property business indebtedness
If you are unsure about whether your canceled debt should or should not be reported as income, you should check with a qualified tax preparer or a CPA for clarification and/or advice about your individual situation.