What is a 1099-C?
By Steven A Leahy
Last week on The IRS Radio Hour, in the question segment, I answered a question about 1099-Cs. I realized that there were a lot more questions about 1099-Cs, so this post will address some of those questions.
A 1099-C is a tax record sent by financial institutions to debtors when the lender forgives or cancels a debt in excess of $600.00. The IRS views the cancelation of debt as a taxable event. That’s right. If a creditor forgives a debt you owed because you could not afford to pay the debt, the IRS may tax you on the forgiven amount. In fact, even if the amount forgiven is less than $600.00, the taxpayer is expected to report that amount as income – even though the financial institution is not required to send a 1099-C.
Generally, taxpayers are to report the 1099-C amount as income. There are, however, certain exceptions and exclusions that often protect the taxpayer from paying additional tax. There are 6 exclusions or exemptions. For example, if a taxpayer has filed for protection under Title 11 (bankruptcy) the discharged debts are not considered taxable income. The “Insolvency Exclusion” is another good example that will protect some taxpayers from 1099-C incomes. To determine if a taxpayer is insolvent at the time the debt is forgiven one looks at assets and liabilities. If liabilities are greater than assets, the taxpayer is technically insolvent. The Insolvency Exclusion only protects a taxpayer to the extent of their insolvency.
In my practice, I see forgiven debt most often in connection to foreclosures or short-sales. After a short-sale or foreclosure sale, the mortgage company often forgives the balance and issues a 1099-C (or a 1099-A, but we will leave that for another blog post). The homeowner is often surprised to receive this tax document and wonders how this will affect them.
In addition to the exclusions mentioned above, Congress passed the Mortgage Forgiveness Debt Relief Act (MFDRA) in 2007. MFDRA has been extended a number of times, most recently on December 16, 2014. MFDRA expired at the end of 2013, so the most recent extension came at the 11th hour and was retroactive – but does not extend beyond the 2014 tax year. That means it will take another act of Congress to extend the Act into 2015 and beyond. Generally, the MFDRA allows a taxpayer to exclude the 1099-C forgiven debts from income if the forgiven debt (up to $2 million) relates to the taxpayers principal residence, regardless of insolvency.
The key to excluding or exempting 1099-C debt forgiveness from taxable income lies in tax preparation. If a taxpayer qualifies for an exception or exemption and fails to prepare the appropriate IRS forms, the IRS will complete an examination and assess a deficiency for that tax year. I have a client that received a 1099-C for a foreclosed property. She used one of the big chain tax preparation companies. The 1099-C was not properly accounted for and they failed to file Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness. The IRS conducted an examination (audit) and assessed more than $100,000.00 in additional taxes, penalties and interest. All of this could have been avoided if she had sought advice from a tax professional versed in these matters.
If you are considering hiring a tax professional to complete your 2014 tax return, consider giving Opem Tax Resolutions and The Law Office of Steven A. Leahy, PC a call. We prepare old unfiled tax returns, as well as current returns. So, if you are a number of years behind in your filing, we can help get you in compliance with the IRS. Call (312) 664-6649 today and ask Bonnie to set up a time to talk me about your tax returns.
If you have a ongoing IRS problem – installment agreement, recent offer-in-compromise or currently not collectible status I recommend the IRS Protection Plan offered by Opem Tax Resolution and the Law Office of Steven A. Leahy, PC. This program anticipates the tax compliance requirements including, timely tax preparation, on-going IRS monitoring, resolution of IRS actions (cancellation of installment agreements or currently not collectible status and defaulting an offer in compromise). In addition, developing a relationship with a tax team will give you access to tax planning to avoid IRS problems in the future and minimize your tax burden.