Will You Owe the IRS Taxes for Income If Your Credit Cards Are Charged Off by the Creditor?

If either the card company or a debt collector charges off your credit card debt, you may be liable for federal taxes on the amount charged off. The 1099-C form filed by the creditor – a "cancellation of debt" notice – is usually the trigger for the Internal Revenue Service to notify you of taxes due on the forgiven debt. Some companies issue a 1099-C form when their right to do so is unclear. If you believe you have been issued the form in error, you may have to prove it, possibly in tax court.

The Internal Revenue Service ruling is that if the debt forgiven is $600 or more, a creditor who forgives the debt must file a 1099-C Cancellation of Debt notice with the IRS and send the debtor a copy. The IRS also requires that debtors pay taxes on the amount forgiven, since it is equivalent to income. The amount forgiven must appear on line 21 of IRS Form 1040 as "other income."

If you have credit card debt and the debt is cancelled by the creditor, the bad news is that once the creditor files the 1099-C, you become liable for the income tax on the debt as of the date of the 1099-C. The good news is that if the credit card company has not followed the IRS regulation regarding notification, you may not have to pay these taxes. However, proving you do not owe the IRS taxes on this income is usually not easy, and you may have to go to tax court to litigate your claim.

Be mindful that a creditor may issue a 1099-C but still pursue you for the debt. A chargeoff of a debt does not mean the debt is forgiven; it may simply mean that the creditor has charged the debt off its books for accounting purposes. Oftentimes, a creditor will deem a debt to be "uncollectible" after 180 days of nonpayment; however, that doesn't mean the creditor won't continue to pursue you for the debt you legally owe. A creditor may decide to pursue you via its own legal department, or it may sell the debt off to a collections agency. In either case, you may be pursued for repayment until the statue of limitations expires. If you receive a 1099-C form, discuss it with your accountant, as that does not necessarily mean the debt is forgiven.