Millions of Americans have had horrible and challenging years due to the Great Financial Crisis and subsequent meltdown. Many are just now beginning to recover from earlier job losses, health issues, mounting debt and even loss of their homes through foreclosure, deed-in-lieu or short sale.
Just as they’re climbing out of the hole they receive a dreaded IRS Form 1099-C or related statement detailing the discharge of indebtedness as miscellaneous income.
What does this mean? If you’ve settled debts, you’re responsible for the ‘discharge’, ‘forgiveness’ or “deficiency” amount. The tax law generally regards the amount any creditor writes off as earned income to you. An example is you settled with your bank by paying $2,000 on a $5,000 credit card debt. The remaining $3,000 that was discharged or forgiven is considered earned income and the IRS wants a share of your ‘good fortune’.
When you file your taxes, you have to file that 1099-C form and declare that $3,000 as income. Forgiven debt can add up quickly. On top of the $60,000 salary you’re making in your new job, perhaps another $200,000 of forgiven debt is added to your salary from those 1099s. In some cases where an exorbitant amount of debt is forgiven, you should contact a qualified tax attorney. There are options you may want to consider unless you can afford to pay taxes on $260,000, or worse, not be able to pay the IRS and have your wages garnished or liens placed on anything you own.
There is one forgiven debt however, that can be exempt from the strong arm of the IRS. Under the Mortgage Debt Relief Act of 2007, some homeowners who were forgiven their mortgage debt can escape paying those taxes. Homeowners who suffered through foreclosure, short sale or deed-in-lieu and have a deficiency (meaning that remaining debt can be considered earned income as in the example above) may qualify for the Mortgage Debt Relief Act. Included in this, is debt reduced through mortgage restructuring such as a loan modification.
The Mortgage Debt Relief Act generally allows taxpayers to exclude the income from the discharge of debt on their principal residence. Up to $2 million of forgiven debt is eligible ($1 million if married and filing separately).
On February 13, 2015, a bill was introduced to the House (H.R.1002 Mortgage Forgiveness Tax Relief Act of 2015) to amend the IRS Code to extend through 2016. The bill was signed into law December 2015. The Act also covers loans and subsequent debt forgiveness for loans that substantially improved the principal residence.
Cancelled debt can be confusing and the IRS forms that need to be filled out are complex and complicated at best. Again, making an appointment with a qualified tax attorney can be the best decision you make on beginning your life-after-debt again.
Gantenbein Law Firm focuses on Tax Law. Our Denver tax attorney can assist you with the best maneuvers and options to avoid IRS tax liabilities and penalties, and the best way to handle a 1099-C. To schedule a consult, call 303-618-2122.
Gantenbein Law Firm also practices Real Estate Law- including Foreclosure Defense and HOA Law, Business Law, Estate Planning, Probate and Wills & Trusts. From our office in Denver, our law firm's lawyers serve clients throughout Colorado. For more information, please visit our website at www.gantenbeinlaw.com.