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forgiven debt and taxes

Forgiven Debt and Taxes

October 07, 2021

Being in debt is not pleasant, but when a debt is forgiven, it can be a huge weight off your shoulders. Although it’s a great relief to no longer owe the debt, you may find that you now owe the IRS. The tax implications of debt forgiveness or cancellation, however, will depend on your individual facts and circumstances.

Form 1099-C, Cancellation of Debt

When a creditor forgives, cancels, or discharges your debt, you should receive Form 1099-CCancellation of Debt. This form will show the amount and date your debt was forgiven or canceled, among other things. If anything on the form is incorrect, contact the creditor immediately and ask them to make corrections where needed. In general, you must report any taxable amount of a canceled/forgiven debt as ordinary income on Form 1040. There are, of course, several exceptions and exclusions to this rule.

Exceptions to Forgiven Debt and Taxes

There are certain kinds of forgiven or canceled debts that qualify for an exception. Per the IRS, these include:

  • Amounts canceled as gifts, bequests, devises, or inheritances
  • Student loan debt forgiven due to your profession or under specific loan forgiveness programs
  • Canceled/forgiven debt that would be deductible if you, as a cash basis taxpayer, paid it
  • A qualified purchase price reduction given by the seller of the property to the buyer
  • Amounts from student loans discharged due to death or total disability of the student

If your forgiven or canceled debt amount falls into these categories, it is not included as income and is non-taxable.

Exclusions From Gross Income

According to the IRS, other cases in which a canceled debt qualifies for an exclusion from gross income and are not taxable are:

  • Debt canceled in a Title 11 bankruptcy case
  • Debt canceled during insolvency
  • Cancellation of qualified farm indebtedness
  • Cancellation of qualified real property business indebtedness
  • Cancellation of qualified principal residence indebtedness that is discharged subject to an arrangement that is entered into and evidenced in writing before January 1, 2021

If you do not qualify for any of these exclusions or the above exceptions, however, you are required to pay taxes on the total amount of forgiven debt.

Forgiven Debt and Unpaid Taxes

Unfortunately, many people who have their debt forgiven or canceled do not pay attention to Form 1099-C and fail to file it with their tax returns. This puts them at risk for tax audits, penalties, and interest fees. Before the IRS comes knocking on your door for any unpaid taxes due to forgiven debt, explore your options. You may be able to file an amended tax return and request a payment plan if you are unable to pay the taxes in full. If you’ve already received a tax bill from the IRS, don’t ignore it. Speak with a tax professional as soon as possible. They may be able to prevent collection actions, such as tax levies and liens, or wage garnishment.