Debt Forgiveness Tax Implications

With tax season just around the corner, there are many filers this year that could be in for a surprise. If you found yourself in debt over your head during the past year and entered into any kid of debt settlement or forgiveness program, you could be in for a shock when it is time to file your taxes. If you sold your home during a short sale, modified your mortgage, negotiated and canceled out credit card debt or entered into any other kind of debt forgiveness program you need to be aware of the debt forgiveness tax.

You may have thought that once you settled on an agreement to forgive a certain portion of your debt that you were now free and clear of that debt, but this is not necessarily true. If the forgiven amount was $600.00 or more, in the eyes of the IRS the settlement amount is considered income. Let’s take a look at how it works.

The IRS, when you enter into any kind of debt settlement program can tax the forgiven amount. The reason behind this is that when you borrowed the money you did not pay taxes on it. When the debt was forgiven, that dollar amount is now looked at as income that you have gained. As a result you will be paying more in taxes for the year and you might possibly even get bumped up into a higher tax bracket. For many people this could be financially devastating.

The lender that settled with is required to send you a 1099-C form for the year that you settled the debt. You will need to claim the income when you file your taxes, unless you qualify for an exemption.

In some cases debt cancelation is not taxable. If you filed for bankruptcy, were forgiven on a farm loan or settled on a non-recourse loan you may be exempt from paying taxes on the forgiven amount. College student loans that are forgiven for pursuing certain public interest occupations also qualify for an exemption. If any of these particular loan circumstances apply to you, there is a form called the 982 that you will need to file along with your tax return.

If you have not already, but are considering entering into a debt forgiveness program, there are some steps you can take to ensure you are not scrambling to pay a high tax bill when you file taxes next year. Claiming fewer exemptions on your current salary can be helpful. You can also start a savings account that you deposit money into weekly or monthly to save up to pay the higher tax bill.