Got Your Debt Cancelled? Watch Out for Taxes

It's a lot likes Jaws; just when you thought it was safe to go back into the water. If you're able to somehow successfully negotiate your debt to zero and you thought you were in the clear. Think again! Yep, panic will set in when you realize it's an all-out shark attack.

The Dreaded Form 1099-C for Taxes

Otherwise knows as the "Cancellation of Debt Form," this nifty piece of paper lets you (and Uncle Sam) become aware of the amount of debt that was cancelled. You may not have had your entire balance cancelled; it doesn't matter, the lender informs you and the government of the forgiven amount. If you've had debt cancelled, you should be receiving this form; don't throw it away. It is an important document.

Although you'd like to, you cannot ignore this form either. Like any other form that goes to the government, it's reporting information to the government. Make sure the information (the amount of cancelled debt) is correct; if not, contact the lender that issued it and have it corrected.

Why Is The Cancellation Of My Debt Important To The Government?

Well, let's just say anything that relates to money is important to the government. And guess what? The government considers the forgiveness of debt as income to you. A lender who accepts at least $600 less than the original balance has to report it to the government and to you. 

Next, you must report the portion of forgiven debt as income. That makes it real tough when it comes to tax time because it's what I call phantom income. The government sees it as income, but nothing showed up in your bank account in the form of a deposit, like real income from work. So, you've got to pay taxes on this transaction that resulted in "income" but you received no cash whatsoever.

Debt: Owe Money Coming and Going

It gets even worse. Sometimes the borrower receives the 1099-C tax form when the lender has sold the debt to a debt buyer. You got it: you are potentially liable for the taxes on the supposedly forgiven debt while also being liable for the debt itself. 

If you ever receive a 1099-C, contact a tax advisor immediately. If one was issued in error, the lender or the debt buyer needs to issue a corrected 1009-C to you and to the IRS.

Liquid Philosophy on Debt

We really hope you never have to experience all thisstress. Start small, but make positive steps to make sure you save up for things before your buy them. That is the only way you can free yourself from the nagging feeling of owing people money all the time. Debt will rob you of your creativity and joy, and that is no way to live.

Have you ever had debt forgiven?