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Cancelled debt as taxable income

Many people in Arkansas feel a sense of relief after negotiating a settlement with a credit card company or collection service. That sense of relief may be diminished in January, when they receive a 1099-C tax form from the company. The 1099-C will show the amount of the debt that was cancelled by the creditor. What many people in Arkansas and other places do not know is that they must file this form with their federal tax return. The IRS considers cancelled debt as taxable income in most cases.

Creditors and debt collectors are required to send a 1099-C form to a former debtor if the difference between the debt settlement and the original balance is at least $600. As an example, if a person agrees to pay $1,000 to settle a $2,000 debt, the $1,000 forgiven by the creditor is considered income. Many people make the mistake of throwing away the 1099-C, thinking that they received it because of a clerical error on the part of the former creditor. However, failure to include this income could lead to a tax audit, penalties and fines.

Not all forgiven or cancelled debt is considered as taxable income. Debt that was cancelled as part of a bankruptcy or home foreclosure may be excluded. Anyone who believes their cancelled debt should be excluded needs to file IRS form 982, which lists the exclusions. Creditors who cancel debts rarely if ever inform debtors that they will send a 1099-C.

Anyone involved in negotiating a settlement of consumer debt may wish to speak with an attorney who has experience in debt relief. The attorney may be able to help negotiate with a credit card company and outline a plan to reduce debt in addition to pointing out potential income tax ramifications.

Source: CreditCards.com, "1099-C surprise: IRS tax follows canceled debt", Connie Prater, November 03, 2014

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