If you were in debt and have been able to get some of that debt canceled, then there are a few things that you need to know. If you don’t, you’ll be going along, thinking the slate has been washed clean, only to get a form from the IRS saying you now owe taxes because of having debt canceled. Before you get side-swiped, read on to learn what you need to know about canceled debt and taxes.
How to Get Debt Canceled
In order to understand any of this, you first need to understand what it means to get debt canceled. Let’s say you owed a credit card debt of ten thousand dollars which you’re unable to keep up with payments anymore. Once the debt gets turned over to a collection agency, they may offer for you to pay only three thousand, having the remaining seven thousand dollars of the debt forgiven. What you need to understand is that although the seven thousand dollar debt has been forgiven, it doesn’t just go away. Whether your debt is credit cards, mortgages, auto loans, or any other type of debt, if an amount has been canceled, it is then considered to be income to those who are no longer responsible for paying it off. Most consumers have no idea that canceled debt is taxed as income and not knowing could lead to an even larger bill. That example is just one way debt can be canceled. There are several other ways as well. Research can answer whether your situation is available for debt forgiveness.
Understanding the Tax Law
Debt collectors and creditors who accept at least six hundred dollars less than your total debt amount are required to file a form 1099-C. Essentially, this claims the canceled debt as income and a copy is sent to consumers in order to use for filing taxes. The form should clearly state how much of your debt has been forgiven and not how much you owed in total. In the above scenario where you owed ten thousand in credit card debt, but only had to pay three thousand, the remaining seven thousand would then be subject to being reported on this form and subsequently, your paying taxes on it. However, sometimes debt collectors and creditors fail to file the correct form, resulting in the consumer not receiving one, in which case you would need to call and ask for it. In addition, when you have debt that has been forgiven, you need to get the agreement in writing. This will act as proof if any part of the debt forgiveness is called into question.
Exceptions to the Law
The IRS does offer a few exceptions to the rule which allow consumers who are in certain financial situations a way to avoid paying taxes on canceled debt. One of these exceptions is when the consumer simply doesn’t have any money with which to pay taxes. If the the consumer is insolvent, having no cash or assets to sell in order to pay the taxes accrued on forgiven debt, then he would not have to pay. This exception only applies strictly to the amount by which the consumer is insolvent. For example, take the same ten thousand in credit card debt. If at the time you have two thousand dollars in cash, you will only be allowed to claim an insolvency amount of eight thousand dollars. However, if the canceled debt then makes you solvent, the amount forgiven is then wholly taxable. There are other exceptions, such as debt forgiven in bankruptcy, but to be sure about your situation it’s best to ask a tax professional.
Perhaps you’ve been hit with this tax already and you’re wondering why you weren’t properly informed about it before hand. According to the IRS, it’s up to consumers to educate yourself on handling debt, including canceled debt. Companies should inform consumers about this tax law, especially those which deal in debt collection and settlement, but not all of them do what they’re supposed to. If you’ve even heard the saying ”ignorance of the law is no excuse” this is definitely one place where it will be applied. Just because a consumer isn’t aware of being taxed on forgiven debt doesn’t mean he can get out of it. Instead, it could end up meaning he pays even more in the end. Keep up with your debt if it’s possible and if not, research anything you feel is pertinent to your case. Find out everything there is to know. Ask a professional for help. The one thing that absolutely doesn’t work here is hoping it will go away. It’s the IRS. They never go away.