Today is tax day, so your federal taxes should be finished and on their way to the IRS, or you should have filed an extension. Even if you’re finished with your taxes, however, you can still fix any mistakes you may have made by filing an amended tax return. One area you may not have considered when filing your 2010 taxes is what happens if you negotiated a settlement of your credit card debt, or if your credit card company wrote off any debt in the last year.
Most Americans don’t realize that if they have more than $600 of debt forgiven or written off by their lender, it is considered income by the IRS.
“Nine out of ten people have no clue about this,” says Chris Strand, director of high net worth services at the Seattle-based CPA firm Bader Martin. “They make a settlement for their credit card debt, and then suddenly, they have taxable income! It’s difficult for many people to understand that concept.”
The IRS considers canceled loan obligations as income because the taxpayer no longer has an obligation to pay. So, if you had credit card debt in the amount of $20,000 and you settled it with your credit card company for only $5,000, the IRS counts the other $15,000 as taxable income.
There are exceptions, including debts discharged through bankruptcy, which are not taxable. If you received a tax form called 1099-C, “Cancellation of Debt,” chances are you need to report the canceled debt as income.
If you negotiated a settlement of your credit card debt, you should have received a 1099-C form
When a lender forgives part of your credit card debt through a settlement, it is required to file a 1099-C “Cancellation of Debt” from with the IRS and send a copy to the debtor. If you walked away from credit card debt without negotiating a settlement, you may also receive a 1099-C form, although it may appear several years afterward.
If you receive a 1099-C form, do not ignore it.
“Very often tax payers don’t know what to do with the 1099-C form, because it’s not a form tax payers see a lot of,” says Gil Charney, a tax researcher at H&R Block’s Tax Institute. “Many people end up putting it away and forget about it. Of course, that could lead to penalties down the road, so it’s very important to report that income.”
First, check to make sure the form is correct. If it is, you need to report the portion of the debt that was written off as income. If you have already filed your taxes and did not do so, you’ll need to file an amended return.
If the 1099-C form does not reflect what you agreed to, or if you did not receive the form, contact your lender.
If you’re considering trying to settle some credit card debt in the future, keep in mind that there are tax consequences. It’s a good idea to get help from an attorney or CPA before you settle a large amount of credit card debt.
Source: CreditCardGuide.com, “Do You Still Owe Taxes on Forgiven Debt?” Eva Norlyk Smith, Ph.D., April 13, 2011