Ask Your Advocate: Can I Be Taxed On a Canceled Debt?

The IRS has a few stipulations

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I had a portion of my debt canceled after working out a debt settlement. A friend of mine said there’s a catch to this arrangement because I’ll have to pay taxes. Is this true? Will I have to pay taxes on the forgiven portion of my debt?

–R. Grant
Queens, NY

It depends on the type of debt that was forgiven. According to the IRS, forgiven debt is taxable because it’s counted as income. And the forgiven amount must be reported as income. You should expect to receive a form from your lender known as Form 1099-C, cancellation of debt. Credit and debt collectors who forgive a minimum of $600 from a debt such as credit card, auto, or mortgage are required to file with the IRS. You’re entitled to a copy of the paperwork.

You didn’t mention what type of debt you had canceled, but there are some cases where you might be eligible for an exclusion from paying the taxes (Note: you may have different tax obligations on the federal and state level). One example is mortgage debt. Under the Mortgage Forgiveness Debt Relief Act, if your mortgage is partially forgiven from 2007 through the 2012 tax years, you might be eligible to apply for tax relief and exclude the forgiven debt from your income. Debts discharged during bankruptcy are also eligible for exclusion.

Your best bet is to check with your tax professional who can advise you of your federal and state tax obligations. (Read “Choosing the Right Tax Professional” Shopsmart, April 2008). You can search the National Association of Tax Professionals online database by zip code to find a tax preparer in your area.

  • Ruth In Delaware

    Ms. Ngo First I want to thank Black Enterprise, your Editor and yourself for taking the time to publish the ladies question from New York. I felt relieved to know that someone other than myself have experienced such a rude awakening from the Federal government. In 2008 I paid of a 6 year old collection account to Americredit. My car was repossed after I had bankrupted in 2003 due to a divorce. I made arrangement to pay off the repossession after negotiating with a collection agency that collected for Americredit February 2008. The representative i worked with never told me I would receive a 1099c??? I asked for a zero balance letter and I have that and I also ask that the repossession status be updated to paid to zero balance on my credit report and the collection agency did that also. However, they left out the minor detail that I would need to show on my 2008 taxes the balance written off as income. I cashed out my IRA from retirement to payoff Collection agency/Americredit $3,400.00. I was desperately trying to make the debt go away. I had already file bankruptcy but the repossession occured afterwards. I have a special needs disabled son who situation took presidence when his father no longer contributed to his care; therefore leaving me no choice but to forfeit my car payment to take care of my family. I work for a college as a clerk typist and make under 30k a year. With that income being so low I walk a tight rope and perform a balancing act with my finances to run my household. I am a junior in college seeking my BA in Communications/journalism so that I can obtain a higher paying position. Nevertheless, I was notifed by the Fed’s that I must payback $1,200.00 + interest by 9/1/2011 and or go to court. I was never notified by the Collection agency that I needed to report the residual amount as income. This was really unfair and I ponder how such a law slithered through both houses and was signed? Why hurt the people who are trying to correct the wrongs. I also found out that my reposessed car was sold at an auction for 5,000.00 well my balance was $5,500.00 when it was repossessed. Yet I paid Collection/Americredit $4,400.00 in 3 installments. Tremendous sacrifice I made to pay this debt only for it to come back and haunt me 1.5 years later. So much unfairness, and now I will need to stop college and risk losing my financial aid and status as an active enrolled student. Reason being in order to pay the fed’s back I have to see additional employment which will take me away from my kids as well plus put me in a higher tax bracket. I don’t even have $100.00 in savings at 42 years old. I am doing the best I can with a gpa of 2.9 3 kids, 1 disabled who needs a lot of attention at home and school, managing work, and have paid all creditors on time for 2.5 years and now this? Don’t know what else to do? But, like I said I am most grateful for the article and I pray that Mr. Graves will somehow do a feature story on this entire 1099c rude awakening situation to so many of us who are trying to do the right thing. But, this very thing is likely to destroy what little finances and my home structure financially. Thanks for publishing and thanks for listening and thanks to the lady in new york for taking the time to send in her question.
    Ruth in Delaware