If you are able to negotiate with a creditor to get your credit card debt written off or you are able to settle for a lessor amount than owed, you may have to pay income taxes on the forgiven amount. The IRS typically considers the forgiven debt to be income consequently you will have to pay income tax on this type of income just as you would any other income.
Why does the IRS consider your forgiven debt to be income? To understand the answer you have to examine how the credit card company treats your forgiven debt. When your creditor determines your debt is uncollectible it will report the amount as lost income thus reducing its tax burden. This lost income will reduce the amount your creditor owes in income tax therefore the IRS will collect the income tax owed on this money from you.
If the principal of the debt forgiven is $600 or more (the amount owed not including any interest or fees), the credit card company must report the amount on a Form 1099-C at the end of the year. The company is required to send this form to you and the IRS, thus ensuring you will report this forgiven debt as income. If you neglect to report this forgiven debt as income, the IRS will send you a notice of the deficiency along with any interest and penalties. Even if you do not receive a Form 1099-C from the credit card company, it is highly advisable for you to report this amount as income on the chance your copy of the 1099-C did not reach you but the IRS received their copy.
The fact that the forgiven debt will be taxable income should be taken into consideration when making the decision on whether to negotiate to have your credit card debt forgiven. Unfortunately, in many circumstances, this is one piece of information which the taxpayer is unaware of until income tax preparation time! If you are able to have a debt forgiven by a creditor, be prepared to set money aside to pay the resulting income taxes so you are not scrambling to come up with the money at tax time.
Submitted by Kathy Shrader
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