When you get behind in your car payment, the auto lender will eventually go through the process of repossessing your car. While the loss of your vehicle can be troubling, it may not be the only problem you have in this situation. In some cases, you may have to pay extra taxes as well.
When you stop making your car payment, the lender will hire a repossession agent to take your car back. The car will typically be sold at auction at that point. The money that is generated from the auction sale will be used to pay off the outstanding debt. If the balance of the loan is greater than what the lender is able to get from the sale of the car, this amount is typically forgiven by the lender.
When you have a car repossessed and sold at auction, it could lead to some increased tax liability for you. When the lender forgives a portion of debt, the Internal Revenue Service interprets this as extra income that you generated. Because of this, you will have to add the amount of the forgiven debts onto your annual income for tax purposes. You will then pay taxes on that amount at your normal marginal tax rate.
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After your car is repossessed, the lender most likely will not inform you of how much the car sold for at auction. Because of this, it may seem difficult to pay taxes on an amount that you do not know you owe. However, when a lender forgives a debt, it must send you and the IRS a form 1099-C in the mail at the beginning of the next year; form 1099-C indicates the amount of the debt that was forgiven. You will then add that amount to your taxable income.
In some cases, having a car repossessed could also affect your business taxes. If the car is used for business purposes, you can usually deduct the amount of interest that you pay on your auto loan. If you have your car repossessed, you will no longer be able to deduct that amount since you will not be paying interest on the auto loan anymore. Because of this, it could reduce your tax deductions and increase your taxes.