Why Is the IRS Asking for Taxes on Forgiven Credit Card Debt?
If you make either a formal or informal arrangement with a credit card company to settle the balance for less than what is actually owed, there may be income tax consequences. In some situations, the IRS will consider the forgiven portion of the debt to be taxable income, and you must include it on your income tax return. Your return may be re-assessed if you do not include it when required, which may result in interest and penalties.
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Debt Settlement Process
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If you are seriously delinquent on your credit card payments, your card company may accept a debt settlement arrangement with you. This card issuer would have to be willing to accept a lower amount than what it due as a complete payment of the debt. The difference between what you owed and what you pay is the forgiven portion of the debt. The IRS considers this to be the equivalent of receiving income, and it will tax the forgiven portion in most situations. Once the debt has been settled, the card company issues tax receipts that you include in your personal tax return.
When to Report to the IRS
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The forgiven debt must be included in income in the year it was forgiven and settled. For example, if you make the settlement arrangement with the company this year, but do not pay off the account until next year, you will include the forgiven amount in your income next year. In the year of the payment, the card company will issue Form 1099-C Cancellation of Debt if the total amount of the forgiven debt is more than $600. The IRS will automatically receive a copy, and it will expect you to include that form in your personal tax return.
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How to Include Forgiven Debt in Income Taxes
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Box 2 on Form 1099-C shows the amount of the forgiven debt that must be included in income. If the credit card was used for personal purposes, the amount is recorded on line 21, Other Income on your 1040. If the card was used for business purposes, report it as income in Schedule C. It's possible the IRS will ask further questions after you file your return if the forgiven debt is not shown on line 21. If that happens, simply provide the IRS with a copy of Schedule C, so it knows you included it there.
Exceptions
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The IRS does not require the forgiven debt to be repaid in certain situations. If the total amount forgiven is less than $600, it does not need to be reported. Also, if the forgiveness was a result of bankruptcy proceedings, tax is not owed. If you have not declared bankruptcy but you are insolvent, you can petition the IRS to forgive the tax otherwise owed. To do this, you must show that your assets are less than your debts and that it would constitute financial hardship to pay the taxes.
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