Is the Schedule 1099-C a blessing or a curse?

Receiving a 1099-C does impact your credit report and score and also has Federal income tax consequences.

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Have you ever received a Schedule 1099-C because you have had some of your debt forgiven? If so, how does this relate to your credit report?

People must pay taxes on any forgiven debt more than $600, according to the IRS. Lenders must report the amount of the cancelled debt on Form 1099-C. If you received debt relief last year, your lender should have mailed you this form which shows the amount forgiven and the original debt amount.

Why is it counted as taxable income? When the money was borrowed it was not taxable because there was a promise to pay it back. After the debt is renegotiated the obligation to pay the entire debt is no longer in place but that does not eliminate the fact that you received the loan.

I am a Michigan State University Extension foreclosure counselor, and several clients I worked with had debts forgiven and the debt still showed up on their credit reports as collectable. Sometimes, even when debt has been forgiven, the lender may not have reported it to the credit-reporting bureaus. The debt may have even been sold to a debt collector. If this happens the creditor may have no legal right to collect once the debt has been forgiven and a Schedule 1099-C issued. It’s best to discuss your personal situation with an attorney who specializes in consumer protection if you can’t resolve the issue on your own.

The Form 1099-C denotes debts that have been forgiven by creditors. It is also known as a “cancellation of debt.” According to the IRS, lenders must file this form for each debtor for whom they canceled $600 or more of a debt owed to them. A 1099-C is sent when a consumer settles a debt with a creditor, or the creditor has chosen to not try to collect a debt. It is important to know that when a creditor is no longer attempting to collect any of the unpaid principal balance on a debt, they must report this amount to the IRS. Review Form 1099-C for accuracy. Financial institutions have issued 1099-C’s for debts they have not tried to collect or issued duplicate forms for the same debt.

An important point to understand is that canceled or settled debts are not the same as debts that have been “paid in full.” If you’ve settled your debts, they will appear on your credit report and are considered derogatory because it basically means your loan went into default. This information can remain on your credit report for up to seven years.

If you are able to get your debt completely canceled, you then no longer have any responsibility for the amount owed. But the creditor must report the canceled amount or settled debt to the IRS using the Form 1099-C cancellation of debt. The amount that was canceled is now considered income to you and it must be reported as such on your tax return.

Tip: Keep in mind that you can settle your debts on your own. One way of trying to make ends meet is to negotiate with creditors. By reducing the amount of debt owed, families can reach agreement on payment plans they can afford. Creditors are usually willing to negotiate a payment plan as they are happier receiving some payment rather than no payment. Paying a company to do it just takes more money out of your pocket that could have been used to pay off some of the debt.

If, at the time your debt was canceled, you had a negative net worth, you may be considered insolvent. This gives you the opportunity to check if you have to report all or part of the charge-off to the IRS. You’d have to file IRS Form 982, "Reduction of Tax Attributes Due to Discharge of Indebtedness," if you want to claim the insolvency exemption.

Given all of that, it may still be a very good idea to settle some or all of your debts. As long as you understand that doing so will technically increase your income resulting in less of a tax refund or putting you in a situation where you have to pay additional federal income tax. Of course, always consult a reputable tax professional with tax-related questions.

If you and your family or someone you know is struggling with creditors there are resources available to help. It is difficult to talk about money problems and can be hard to put your situation into words when dealing with creditors. The MSU Extension website MI Money Health has many tips and sample letters to write creditors. Families must be honest about their situation and have a reasonable plan they can afford. Also, it is important to get any agreement in writing.

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