Form 1099-C

• When a lender cancels a personal debt, that lender will send you and the IRS a Form 1099-C. The amount it reports on the form is the total debt it has canceled for you during the tax year. When a lender decides to cancel a debt you owe, regardless of the reason, it has an obligation to notify you of your potential tax liability in the same way an employer must notify you of your taxable earnings on a W-2 each year. Even if you receive this form, you should still evaluate whether the canceled debt is taxable. The opposite is also true; you may still have a taxable cancellation of debt, but never receive a 1099-C.
  
  

Interest

• For those canceled debts that are taxable, you may need to pay additional tax on the interest the creditor no longer requires you to pay. You can generally make this determination by evaluating whether the interest is ordinarily deductible when you pay it. If the answer is no, then you must include the interest in taxable income. For example, if the lender for your home equity loan cancels your debt as well as some of the interest payments that are in arrears, you don't have to include the interest in your taxable income because this type of interest would be deductible on your tax return. But if the canceled debt relates to your credit card, you must include that interest since in most cases, the interest is not deductible. Your credit card company should be able to tell which portion of your canceled debt represents past-due interest.
  
  

Discounts and Modifications

• Your lender may agree to reduce the amount you owe if you are having problems making payments or are significantly past due. If this occurs, you must include the amount of the reduction in your taxable income. This frequently occurs with credit card debt when you are able to negotiate a lower payoff amount. Suppose you owe $5,000 on your credit card, and the lender agrees to reduce it to $1,000 if you agree to make the lump-sum payment within seven days. If you agree, you must pay tax on the $4,000 reduction.
  
  

Exceptions

• In some cases, you will not have to include the cancellation in your taxable income. Common examples include a federal government employee who obtains a cancellation of some student loan debt or an instance in which the repayment of the actual debt would be tax deductible, such as when a sole proprietor pays business expenses on credit. If you file bankruptcy, it's likely that a portion of your debt will be canceled. This type of cancellation never will result in taxable income to you.