If either the card company or a debt collector "forgives" 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."
Good News and Bad News
If you have credit card debt, 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. Gerri Detweiler, who writes on credit card debt for Credit.com, warns, however, that proving you do not owe the IRS taxes on this income is usually not easy. She cites one taxpayer who fought and won, but only after taking the claim to tax court.
The Essence of the Claim
The IRS requires the 1099-C notice to be sent within 36 months after the creditor stops collection efforts. After 36 months, the collector's right to send the notice expires. Also, the credit card company cannot legally send the 1099-C notice if either the company or a debt collector is still actively pursuing collection.
What to Do
There's no clear-cut process for correcting the situation when the creditor wrongly issues a 1099-C. One CPA recommends calling the IRS and asking the IRS representative for help in filing Form 4598: Form W-2, 1098, or 1099 Not Received, Incorrect or Lost. The IRS then sends the creditor a request for a corrected Form 1099. If the creditor does not file the corrected 1099-C within 10 days, copying you, you then have the right to attach a copy of Form 4598 to your tax return, along with an explanation of the facts -- that the Form 1009-C was not filed in a timely fashion or that the creditor is still trying to collect, and that no taxes on the debt are due.
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