Tuesday, April 5, 2011

Does Cancelled Debt Have To Be Reported On My Income Tax?

Exterior of the Internal Revenue Service offic...Image via WikipediaIt was worth it, you had to jump through a few hoops but that credit card canceled your debt. It was a great feeling not having to worry about that anymore. But you received in the mail a 1099-C that states you you owe taxes on that forgiven debt. Do you have to report it on your tax, you don't have to but expect a stern letter from the IRS if you don't.

Don't even think about ignoring it because Uncle Sam gets a copy of that 1099-C, too. They are going to be looking for it on your tax return. A Form 1099-C is issued when a debt of $600 or more is forgiven or canceled.

The IRS stated that the number of 1099-C's grew from 1 million forms to 1.9 million forms in 2008. Estimates for 2010 go as high as 3 million 1099-C forms. It's strange because people that couldn't pay their debts are now expected to pay taxes. So they will be forced to put the tax bill on their credit card and here we come full circle.

If you have $50,000 in debt forgiven , expect to pay $15,000 in taxes.

But be careful, all forgiven debt is not taxable. If you had a student loan that was forgiven because you worked in an under served community, it's not taxable. But the forgiveness of the remaining student loan balance after 25 years in an income-based repayment program is taxable. Given the complex rules, you should provide the 1099-C to the tax preparer. This applies only to a principal residence — not a second home. And the exclusion applies only if a foreclosure or short sale takes place from 2007 through 2012. The canceled debt must have been incurred to buy, build or improve your main home.

As with all things of this complexity, seek out a competent tax accountant to do it right.

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