Creditors may forgive, but the IRS won’t forget. That’s the takeaway for many types of canceled debt. The forgiven debt is often seen as income subject to taxes.
For example, if you are unable to pay your credit card bill and negotiate with the card issuer to a reduced amount, the amount of reduction is what is subject to taxes. So if they are willing to accept $4000 even though you owe $5000, you’ll owe taxes on the $1000 that they forgave. Negotiating a lower interest rate for future payments won’t incur this burden, but if you work out a lower rate which is applied retroactively, then that too may be considered forgiven debt subject to taxes. Creditors will generally report your forgiven debt to you (and the IRS) as miscellaneous income on form 1099-C. You are resposible for taxes even if the creditor does not send you the form, which could happen if the forgiven debt is less than $600.
Not all canceled debt is taxable. Congress passed a temporary measure to make forgiven mortgage debt on your primary residence, up to $2 million, exempt from tax for 2007-2009. Forgiven debt on a secondary residence, or proceeds from a HELOC not used to improve the primary residence are subject to taxes. You probably won’t be taxed on debt canceled in bankruptcy proceedings or if you are insolvent.
If your forgiven debt is large and taxable, you should probably pay estimated taxes on the amount. Not following such “pay as you go” provisions could lead to additional penalties from the IRS, in addition to a large tax bill. In simplified terms, if you are forgiven $10,000 and are in the 25% tax bracket, you would pay about $2500 in estimated tax payments. You can use the IRS’s estimated tax worksheet to figure out the actual amount.
It may seem surprising at first, but when you think about the nature of forgiven debt, it really is like income that was given to you by the creditor. As such, it seems reasonable (or reasonable as taxes go) that the amount should be taxed.
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April 28th, 2008 at 3:11 pm
[…] Taxes Due on Cancelled Debt Creditors may forgive, but the IRS won’t forget. That’s the takeaway for many types of canceled debt. The forgiven debt is often seen as income subject to taxes. For example, if you are unable to pay your credit card bill and negotiate with the card issuer to a reduced amount, the amount of reduction is what is subject to taxes. So if they are willing to accept $4000 even though you owe $5000, you’ll owe taxes on the $1000 that they forgave. Negotiating a lower interest rate for future payment […]
April 28th, 2008 at 4:07 pm
[…] rhbee wrote an interesting post today onHere’s a quick excerptCongress passed a temporary measure to make forgiven mortgage debt on your primary residence, up to $2 million, exempt from tax for 2007-2009. Forgiven debt on a secondary residence, or proceeds from a HELOC not used to improve the … […]
April 28th, 2008 at 5:26 pm
[…] Mike wrote an interesting post today on Taxes Due on Cancelled DebtHere’s a quick excerptCreditors will generally report your forgiven debt to you (and the IRS) as miscellaneous income on form 1099-C. You are resposible for taxes even if the creditor does not send you the form, which could happen if the forgiven debt is … […]
April 28th, 2008 at 6:26 pm
[…] Taxes Due on Cancelled Debt The forgiven debt is often seen as income subject to taxes. For example, if you are unable to pay your credit card bill and negotiate with the card issuer to a reduced amount, the amount of reduction is what is subject to taxes. … […]
April 28th, 2008 at 7:43 pm
[…] Taxes Due on Cancelled Debt For example, if you are unable to pay your credit card bill and negotiate with the card issuer to a reduced amount, the amount of reduction is what is subject to taxes. So if they are willing to accept $4000 even though you owe $5000, … […]