When Do You Have to Pay Taxes on Unpaid Credit Card Debt?
The Internal Revenue Service (IRS) views forgiven or canceled debt as taxable income, based on the assumption that debt forgiveness amounts to a personal net gain for the debtor. Therefore, the IRS normally requires debtors to pay standard income tax on canceled debts.
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Tax Liability
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When you settle a credit card debt for less than you owe, or a creditor writes off your unpaid debt as a loss of business income, an unpaid amount of $600 or more qualifies as taxable income. Normally, you must pay income tax on this amount when you file your tax return in the following year. However, certain factors may exempt you from having to pay this tax. For instance, if you were insolvent when the creditor canceled your debt --- meaning that your total debts exceeded your total assets --- you may be exempt from this tax. (Note, though, that you must still report the canceled debt on your tax return.) Individual circumstances vary, so consult your tax professional or attorney for specific advice on your tax liability for unpaid debt.
Consequences
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Legally, a creditor who writes off or settles an outstanding debt of $600 or more must send a copy of IRS Form 1099-C to the debtor and to the IRS. This means that the IRS has a record of the "income" the debtor received through debt cancellation, and will enforce the debtor's obligation to pay any taxes due on it. If you fail to report a canceled debt on your tax return, it could trigger an IRS audit. Furthermore, unpaid taxes accumulate interest and penalties, which means that the amount you owe will keep growing larger until you pay it.
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Tax Liens
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If your tax bill remains unpaid for a sufficient time, the IRS can issue a tax lien or tax levy against you. A tax lien is a claim by the IRS on any property you own now, or may own in the future. It notifies you and any creditors you may have of the government's right to secure the property. A tax levy is the actual seizure of a debtor's property by the government, with the intent to sell it to pay outstanding taxes.
Warning
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Like late payments, collection accounts and debt settlements, tax liens will appear on your credit report and adversely affect your credit score. As of 2010, an unpaid tax lien can remain on your credit report for up to 10 years in California, and indefinitely in all other states. The IRS will release the lien upon payment, but notice of the lien will typically remain on your credit report for seven years from the date of payment. A tax levy will not appear on your credit report.
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References
- Nolo: Tax Consequences When a Creditor Writes Off or Settles a Debt
- Internal Revenue Service: IRS Notices and Bills, Penalties and Interest Charges
- Internal Revenue Service: File a Notice of Tax Lien
- Internal Revenue Service: Levy
- MyFico: How Do Public Records and Judgments Affect My FICO Score?
- Equifax: Length Of Credit History
Resources
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