You finally did it. You filed your taxes and now need only await your return, to be spent on a new TV or stocked away in an IRA or whatever you want — it’s your money again, and not Uncle Sam’s.
Unfortunately, it’s possible for this state of reverie to be interrupted by something called the 1099-C — a form taxpayers receive when a creditor cancels a debt worth more than $600.
So if, for example, you have a student loan forgiven and the forgiven amount is more than $600, that counts as additional taxable income and you should expect a 1099-C in the mail. Or, if you renegotiate with a credit card company to pay less than you owe, and the difference is more than $600, expect a 1099-C. The form itself will give the specific reason in Box 6 via a code that you can look up on the IRS website.
No matter the exact reason, just know that, while it’s great to get rid of debt, it can still have consequences come tax time. Canceling a debt may also affect your credit score. Keep up with yours using Credit.com’s free credit report summary, which provides your two free credit scores, updated every two weeks.
Once you know why the 1099-C is in your mailbox, what do you do with it? The 1099-C might seem like just another form to plug into your tax software or give to your accountant. The problem is, the time the 1099-C arrives can vary, and the form may arrive after you’ve already filed your taxes, said Lisa Greene-Lewis, a CPA and tax expert for TurboTax.
Regardless of when the 1099-C arrives, if the debt was canceled in 2016, you have to include it with that year’s return, Greene-Lewis said. Here’s what you can do if you’ve already filed.
Amending Your Return
In some cases, you may not have to do anything. Your creditor should have filled out a 1099-C and sent it to the IRS when they forgave the debt.
The IRS may do an adjustment on your return automatically and send a notice asking if you agree. If not, you’ll have to amend your return, Greene-Lewis said.
Tax software like TurboTax can guide you through the process; otherwise, you’d file a form called a 1040X and include the information in the 1099-C.
You don’t have to report forgiven debt as income in a few cases. If a debt was discharged because of bankruptcy, you don’t have to pay tax on it. Same if you’re considered insolvent, Greene-Lewis said.
Also, if you had debt on a mortgage discharged in 2016, you don’t have to include it in your taxable income, thanks to the Mortgage Debt Relief Act’s extension through last year, Greene-Lewis said.
Will This Hurt My Return?
It depends on how much debt was discharged. If it was enough to bump you up to a higher tax bracket, then yes, a 1099-C could shrink your return, Greene-Lewis said.
In addition, you’ll likely pay a penalty if you file the amendment after April 15, even if the 1099-C showed up after the deadline.
It’s rare, but Greene-Lewis said she’s heard of 1099-C forms showing up after the filing deadline. You can include an explanation as to why you’re filing late on the amendment, but it’s not always enough to avoid the wrath of the Internal Revenue Service.
Taxes can get confusing — just looking at the names of some of the forms you have to fill out can be enough to get your head spinning. Like the 1099-C, for example. What is that, and why is it in your mailbox? Well, we’re here to help and answer all your 1099-C questions.
What Is a 1099-C?
“A 1099-C is a document sent by a bank when they have canceled a debt,” Craig W. Smalley, EA, founder and CEO of CWSEAPA, LLP and Tax Crisis Center, LLC, said. “For instance, if you have negotiated with your credit card company to pay them a lesser amount than you owe them, the difference would be reported on this form.”
Bruce McClary, the vice president of communications at the National Foundation for Credit Counseling, said this is an important reason to “be familiar with the tax consequences when considering debt settlement as an option. You don’t want to be blindsided by a costly IRS bill when you may already be struggling financially.”
Why Did I Get a 1099-C?
If you have had a canceled debt, expect to see a 1099-C arrive in your mail, as “the bank is required to send this form, because it is taxable income,” Smalley said.
According to the IRS, lenders file a 1099-C if you have $600 or more of debt that is canceled. Here are four common reasons that may be the case.
You settled a debt for less than what you originally owed and the creditor picked up the remaining balance (debt forgiveness).
You did not pay on a debt for at least three years, and there was no collection activity for the past year.
Your home was foreclosed and your deficiency (the difference of what was owed and the value of the home) was either forgiven or you haven’t paid it.
Your home was sold in a short sale, and you made a deal with your lender to pay less than what was due.
Still not sure why you received this form? Look for Box 6, which will give you a code explaining why the lender sent it. To decipher the code, you can reference Publication 4681 on the IRS website.
Do I Have to Fill Out a 1099-C If I Filed for Bankruptcy?
Just like with most things, there is an exception to the rule of all canceled debts requiring a 1099-C. Smalley said that “if a debt is canceled because of bankruptcy, you do not have to pay tax on it.” (Remember: Bankruptcy does have a major negative effect on your credit scores.)
If I Receive a 1099-C, Does That Mean My Debt Is Paid?
This depends on why you received the 1099-C in the first place. If it’s because you settled your debt, then yes, your debt is resolved. However, if it’s because you haven’t made any payments on a debt for three years and the debt collector hasn’t tried to collect recently (noted in Point Two above), then your debt is not in the clear and you may still owe.
What Do I Do If I Get a 1099-C for a Debt I Paid?
“First and foremost, contact the issuer of the 1099-C and ask them to make the necessary corrections,” McClary said. “They will need to send you a corrected 1099-C in time for you to file taxes.”
McClary also noted that if this request doesn’t work, “the IRS has a dispute process you can use. This requires that you reach out to the IRS and let them know you wish to submit a complaint about an incorrectly issued 1099-C. They will provide you with Form 4598 that you will have to attach to your tax return, along with any additional documentation that supports your claim.”
Do I Have to File a 1099-C in the Tax Year I Receive One?
“There is no statute, as the form is to be issued in the year that the debt is canceled,” Smalley said. If this isn’t the case for the 1099-C you received, contact the issuer or the IRS immediately to find out the reason you were sent a 1099-C and to remedy any problems.
If I get a 1099-C, Is That the Amount I Owe or the Amount I’m Paying Taxes On?
“It is the amount that you are paying taxes on,” Smalley said. “However, if you are insolvent, meaning you have more liabilities than assets, certain cancelations would not be taxable. You have to fill out another form, and you have to make sure that you have evidence to support that you are insolvent.”
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Donald Trump’s taxes have been a centerpiece of the election cycle — but the particular tax issues he’s faced have likely been beyond the pale for average Americans. Questions about releasing his returns, how much he’s donated to charity and whether his nine-figure losses should have offset his federal income tax responsibilities are not the kind of things most of us have to deal with as the April 15 tax deadline looms.
That changed a bit earlier this week, however, with a story in the New York Times that looked at how Trump was able to avoid reporting hundreds of millions of dollars in taxable income in the 1990s. It turns out the issues he may have been dealing with aren’t necessarily so different than those faced by millions of Americans — albeit on a much larger scale.
How Canceled Debt Affects Your Taxes
The issue revolves around canceled debt. When someone owes a bank some money, and they are no longer able to pay that money back, they may negotiate with the bank for a cancellation of all or a portion of that debt. This can happen in foreclosures, short sales and even when people owe money on their credit cards that they can’t afford to pay.
Let’s say, for example, you owe $25,000 on a credit card, but you simply can’t afford to pay it all back, and the interest and fees make it unlikely that you’ll ever be able to pay it back. You call up the bank and explain the situation and they agree to do a deal wherein you pay them $10,000 and they forgive the remaining $15,000. In addition to the credit consequences (that $15,000 in canceled debt will likely be documented on your credit report) there are tax consequences too. The IRS treats canceled debt like this as income, which means you’ll have to pay taxes on it, just as you would for your salary. People in this situation will often get a form called a 1099-C in the mail which documents this tax liability. Sometimes these forms come many years after the debt is forgiven. We’ve written about 1099-C problems extensively in the past and many people have no idea about potential tax liabilities when they are negotiating debt forgiveness with a financial institution. In fact, nearly 6 million Americans get 1099-Cs in the mail every year.
Trump’s Canceled Debts
So what does any of this have to do with Trump? A New York Times story by David Barstow, Mike McIntire, Patricia Cohen, Susanne Craig, and Russ Buettner published earlier this week looked at how the mogul allegedly dealt with his canceled debts in connection to overall losses in his casino business.
“As that empire floundered in the early 1990s, Mr. Trump pressured his financial backers to forgive hundreds of millions of dollars in debt he could not repay. While the cancellation of so much debt gave new life to Mr. Trump’s casinos, it created a potentially crippling problem with the Internal Revenue Service. In the eyes of the I.R.S., a dollar of canceled debt is the same as a dollar of taxable income. This meant Mr. Trump faced the painful prospect of having to report the hundreds of millions of dollars of canceled debt as if it were hundreds of millions of dollars of taxable income.”
So what did Trump do? According to the Times, he may have been able to offset those tax liabilities by using a stock-for-debt swap provision that existed in the tax code at the time. Here’s how the Times describes it:
“The strategy, known among tax practitioners as a “stock-for-debt swap,” relies on mathematical sleight of hand. Say a company can repay only $60 million of a $100 million bank loan. If the bank forgives the remaining $40 million, the company faces a large tax bill because it will have to report that canceled $40 million debt as taxable income.
Clever tax lawyers found a way around this inconvenience. The company would simply swap stock for the $40 million in debt it could not repay. This way, it would look as if the entire $100 million loan had been repaid, and presto: There would be no tax bill due for $40 million in canceled debt.
Best of all, it did not matter if the actual market value of the stock was considerably less than the $40 million in canceled debt. (Stock in an effectively insolvent company could easily be next to worthless.) Even in the opaque, rarefied world of gaming impenetrable tax regulations, this particular maneuver was about as close as a company could get to waving a magic wand and making taxes disappear.”
According to the Times, Trump allegedly stretched this strategy one step forward by swapping debt with partnership equity in his then-flailing casinos.
Trump, who is no fan of the New York Times, declined to comment for the article. (His campaign also did not respond immediately to Credit.com’s request for comment.) Trump’s spokesperson, Holly Hicks, did send the Times this statement in an email: “Your email suggests either a fundamental misunderstanding or an intentional misreading of the law… Your thesis is a criticism, not just of Mr. Trump, but of all taxpayers who take the time and spend the money to try to comply with the dizzyingly complex and ambiguous tax laws without paying more tax than they owe. Mr. Trump does not think that taxpayers should file returns that resolve all doubt in favor of the I.R.S. And any tax experts that you have consulted are engaged in pure speculation. There is no news here.”
So how does all of this this relate to the average American who may have gotten a 1099-C in the mail and is facing a steep tax bill because of canceled debt? Well, given Congress banned stock-for-debt swaps in 1993 and equity-for-debt partnerships back in 2004 in order to eliminate the potential for abuse, no one will be able to replicate the strategy The Times alleged Trump to have used. Nevertheless, imagine if this option were available to everyday Americans. What might it look like?
Let’s go back to our earlier example: the $25,000 credit card debt. Let’s say the bank has agreed to forgive the whole thing, but you don’t want to get stuck paying income taxes on that $25,000. Since you’re an average American who doesn’t have stock to trade away and can’t do a “stock-for-debt swap,” let’s call this a “sock-for-debt swap.” You send the bank a cardboard box full of your old socks and tell them that they are worth $25,000. They bank doesn’t really care, because they’ve already forgiven the debt and written it off their books, but you get to tell the IRS that the bank hasn’t really “forgiven” anything. You traded that credit card debt for $25,000 worth of fabulous, beautiful, old socks. So you’re in the clear.
What to Do if You Get a 1099-C
The reality is most Americans can’t make much of an argument when they get a 1099-C in the mail. Still, there are a few steps you can take if you are really in dire straits and can’t afford to pay.
Consumers might be able to avoid paying taxes on canceled debts by claiming the insolvency exclusion. Per the IRS, a taxpayer is insolvent when their total liabilities exceed his or her total assets. You may also be able to avoid paying if the debt was discharged in bankruptcy. You can go here to learn more about what to do if you get a 1099-C.
If you can’t pay back a debt you may be able to settle it for less than what is owed. The goal in doing so is pretty straight forward — you want to get the creditor to accept a lower payment amount than the current balance on the loan or account. However, getting there can prove to be a challenging task and there are some mistakes you’ll want to avoid when trying to settle a debt.
1. Having Unrealistic Expectations
You may have heard you can settle a debt for pennies on the dollar, in the 10-25% range. That may be idealistic, so you shouldn’t expect it to go that way.
“While you may be able to negotiate down your debt, it’s important to remember that lenders are typically for-profit businesses accountable to shareholders,” John Schneider of the Debt Free Guys, and Credit.com contributor, said.
2. Overlooking Tax Consequences
Any time a debt is forgiven or settled, the IRS treats the forgiven amount as taxable income, and the creditor will most likely issue you a 1099-C. If you don’t keep this in mind, you may be faced with a surprise when Tax Day comes along.
“You’re not done paying for your debt when you send your settlement check,” Schneider said. “However, the amount of tax you may owe on this income or settlement amount will depend on other assets you have.”
3. Negotiating Too Early
“It seems counter-intuitive, but the more you demonstrate your inability to pay your lender back, the more inclined your lender will be to negotiate,” Schneider said. “Missing a few payments wouldn’t qualify.”
Many credit card companies may not be willing to negotiate with you until you are at least 90 days delinquent. In addition, being premature in the process may refer to the fact that you don’t have a full grasp on your financial situation.
“The ‘too early’ would be that you should have a budget and [know] what is possible before negotiating,” Thomas Duffany, an Accredited Financial Counselor, said. (For more, you can read this guide on tips for negotiating with creditors.)
4. Not Getting Help Negotiating
The person you talk to on the other end of the line at the credit card company or the collections firm is a professional whose skills may be intimidating.
“The person who negotiates for the lender is an expert at negotiating,” Schneider said, so asking for help might be a good option. “If you need to bring in a friend or a colleague more skilled with negotiating to speak on your behalf it may be worth it.” There are also professional organizations that can help negotiate — if that’s the route you choose, consider reading this guide that goes over 14 questions you should be asking a debt settlement company.
“Navigating issues of debt can be stressful, confusing, and frustrating,” Rebecca Wiggins, executive director of the Association for Financial Counseling and Planning Education, said. “It is important that consumers know where to turn and who they can trust to guide them to financial security.” She recommended consumers “look for a trusted professional with reputable credentials and comprehensive training.”
5. Settling for an Amount You Cannot Afford
It’s no good negotiating a settlement if you wind up defaulting on the new agreement, essentially putting you back in the same stressful situation.
“It is essential that consumers have an updated spending plan to understand income, expenses and debt,” Wiggins said. “It will also help to determine how much they can afford to pay toward debt.”
6. Not Getting the Agreement in Writing
Getting a creditor or collection agency to agree to a settlement is only part of the process — once you get them to agree, it’s essential to get the agreement documented in writing. Oral contracts are extremely difficult to enforce, so having a written agreement spelling out the terms of the agreement exactly will help you should you need to enforce the contract in court.
According to Todd Christensen, the director of education at the National Financial Education Center in Boise, Idaho, said it’s important that “… anyone setting a debt should get in writing that the creditor will not sell (send to collections) any remaining amount not paid.” You’ll also want to outline the other terms of your agreement in writing.
As you continue to work on paying your debts, it’s a good idea to monitor the effects it’s having on your credit. You can view two of your credit scores for free, updated every 14 days, on Credit.com.