Law Office of Allan E. Dunaway, PLC

Cancelled debt may return as a tax bill

Anyone in Kentucky who has their credit card debt forgiven in whole or in part can expect to receive a 1099-C form from the issuer or collection agency. When this form is sent out, it is also sent to the Internal Revenue Service. In many cases, the amount of cancelled debt becomes taxable income for the card holder and could potentially result in a very large tax obligation.

When a credit card is active and the card holder is making payments, the borrowed money is not considered income. However, once the card holder defaults on the agreement and the outstanding balance is cancelled, the amount that was borrowed and not repaid is often taxed as income. There are some special circumstances that might help a person avoid being taxed on cancelled credit card debt.

If the former card holder is insolvent, meaning their assets are valued at less than the amount of their debts, the IRS may not require them to pay taxes on the cancelled debt. These debts are also not taxable if they were discharged through bankruptcy. When a credit card holder gets relief from their debt by filing for Chapter 7 or Chapter 13 bankruptcy, the IRS will not require them to include the discharged amount in their annual income for the year the debts were forgiven.

An attorney who has experience in bankruptcy law may be able to assist a client who is facing a huge tax bill based on a cancelled debt. A lawyer might explain the client's options and help them determine whether they qualify for insolvency. If they are struggling to pay other bills or have a wage garnishment order in place, filing for bankruptcy might be a viable option.

Source: Monterey Herald, "Barry Dolowich, Tax Tips: Cancellation of debt income", Barry Dolowich, Feb. 17, 2015

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