Be Careful: You Can Still Be Taxed on Cancelled Debt

By Robert Jacovetti

If you want to negotiate your debt with your creditors, you need to make sure you have an experienced debt relief attorney on your side. Any debt that is discharged or cancelled by the creditor is considered “taxable income” for you.

It’s understandable that you might overlook the potential tax consequences of cancelled debt because your primary concern right now may be taking care of your financial obligations. Perhaps the reason for the discharge of debt is a traumatic event such as a serious injury and subsequent hospitalization. As a result, you may not be in the best position to recognize the tax implications down the road. However, the tax consequences of discharged debt are very real.

Don’t Ignore the 1099-C Form for Cancellation of Debt

Keep in mind that the creditor might not provide you with notice of the tax impact of the debt cancellation because they are only interested in getting paid. Many people simply do not realize that there are tax implications for negotiating a settlement with creditors. For example, perhaps you owe $12,000 on a credit card and attempt to negotiate a deal with the credit card company to pay a lower amount (e.g., $7,000) and wipe off the rest of the debt. If the company agrees to let you pay less and accepts a lower amount, they will file a cancelled debt income 1099-C form because there are still federal tax consequences on the remaining 5K balance.

Later, you are going to get a federal tax bill and you will have to pay taxes on that $5,000 – even though the $5K balance was wiped out by the creditor. Depending on your tax bracket, that number can be exorbitant.

There are ways to get out of debt while also avoiding federal and state implications. It may be possible for a qualified expert in this area to dispute the taxation of your cancelled debt as income. For example, some exceptions to 1099-C implications include debts cancelled in bankruptcy, debts cancelled while the borrower is financially insolvent and certain student loans.

A qualified consumer debt attorney can look over the facts of your case and determine whether you qualify for an exception to reporting the discharged debt as income.

Contact an Experienced New York Consumer Debt Lawyer

It is important for you to confer with a consumer debt attorney and a seasoned tax accountant before you make any final decisions about how to handle your debt. Cancelled debt doesn’t automatically have to be taxable. You should consult with a qualified consumer debt lawyer because you need professional guidance right now.