There can’t be anything more bothersom than piling of debts. Most of us try and ask our lenders to lend some relief by cancellation of debt. But, not all succeed in the process. If you are planning to talk to your lender on cancelling a part of your debt or if already have spoken about it, did you know that the cancelled debt can be taxable? Most of us try the cancellation on credit card debt. When this cancellation occurs, you have to report the amount cancelled by the lender to the Internal Revenue Service. This amount is usually considered taxable income. We may experience the relief from the cancellation of debt, but usually forget the tax billing for the cancelled debt. Knowing what can be done and how to report to the IRS surely can help you review the options available to exclude the cancelled amount from your income.

When your lender agrees to cancel a part of your debt, they may issue you a Form 1099-C, “Cancellation of Debt”. The form will have the details of the name, address, the amount of debt cancelled and others. When you file your taxes, this amount must be reported in Form 1040 as “other income”. You can check if your cancelled debt falls into any of the exceptions. The debt discharged through bankruptcy, student loan forgiven by the educational institution and debt from mortgage on primary residence are some of the exceptions for which the cancelled debt is not taxable.

Generally, lenders agree for a debt cancellation when the statute of limitations has expired or if you had made any agreement with the lender to cancel the debt after a period of time. The federal law states that any lender cancelling debt greater than $600 should send Form 1099-C “cancellation of debt” to the debtor. The amount cancelled must be reported on Form 982 and attached with the tax return papers. Mostly, debt cancelled is considered as taxable income by the IRS. However, certain situations are considered exceptions. If your net worth was negative during the cancellation the cancelled debt may be non-taxable. The debt cancelled through Mortgage Forgiveness Debt Relief Act can also be an exception. However, the state laws differ from the federal laws. Consultation with professional experts on tax and state laws may help you in reporting the cancelled debts.

Sometimes, the amount owed to IRS when not settled promptly may result in tax debt. Tax debt negotiation can help you lower the amount owed. You first need to estimate your Reasonable Collection Potential (RCP), the method used to measure your ability to settle tour tax debt. If the net value of your assets is lower than your tax debt, you may try applying for an Offer in Compromise (OIC) to lower the tax debt. You may have to file the Form 656, Offer in compromise. If you qualify for the program, you can pay back the tax debt as scheduled. Factors like the state in which you live and the source of income to pay back the tax debt may determine the future payments schedule. Making settlement with the IRS may not be an easy task. It can take many months and approvals from several levels of the IRS to finalize the settlement. Consultation with professionals and their help to file taxes and to negotiate for settlement can make tasks easier and sooner.

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Category: Finances
Keywords: cancellation of debt, debt cancellation, tax debt negotiation