There is a lot of confusion when it comes to figuring out when to use IRS Form 1099-C. As the recipient of a 1099-C, meaning you’re the one whose debt has been cancelled, you may need to report the amount as taxable income on your 1040. This is because the IRS treats many types of debt cancellations as if you received a payment of income that’s subject to tax.
Who Files Form 1099-C
A creditor must wait until the occurrence of an event warranting cancellation of a debt before report it on a 1099-C. This generally occurs when creditors realize the possibility of collection is small, such as when a debtor seeks bankruptcy protection, the statute of limitations on collection is expiring or when the cost of collecting a delinquent debt is likely to cost more than debt itself. However, just because the IRS requires a creditor to file a 1099-C for your cancellation of debt, it doesn’t always mean it’s taxable on your return.
1099-C Reporting Exceptions
If your debt cancellation qualifies for an exclusion or exception, which allows you to avoid paying income tax, you don’t have to report the amounts from Form 1099-C on your tax return. Otherwise, boxes 2 and 3 of the 1099-C must be reported on the “other income” line of your tax return.
Debt Cancellation Exceptions
Exceptions exist that can eliminate your obligation to report amounts from a 1099-C on your tax return. Some of these exceptions apply to federal student loan cancellations if it relates to your employment with a government agency or school. An exception also applies to debts that would be tax deductible if you paid them, such as ordinary and necessary business expenses you incur on credit, for example. A commonly used exception is also available for any reduction in your mortgage balance reported on 1099-C that’s made pursuant to the Home Affordable Modification Program.
Debt Cancellation Exclusions
When you’re unable to satisfy the requirements of an exception, there are some exclusions you should consider. An exclusion applies to 1099-C debt cancellations that occur as part of a bankruptcy, during periods you’re insolvent—meaning your debts exceed your assets—and in some cases where your lender cancels some of your mortgage repayment obligations for your principal residence. But if you exclude canceled debt on your principal residence, you’ll also need to reduce your home’s tax basis by the amount reported to you on 1099-C.