Most people know that if they receive cash, it is probably taxable unless it is an honest to goodness gift. Most people know that if they receive property, that the property is probably also taxed, again, unless it is a true gift. More about gifts below. But how about what happens if it doesn’t seem that you got anything? Say your uncle loaned you money, and then says don’t worry about paying me back? Can that somehow be taxed?
With the IRS, COD is short for "cancellation of debt." Like it or not, when a debt you owe is canceled or discharged, in many cases the tax code treats the wiped-out debt as cash income to you that you must report. If you owe $500,000 to the bank, but the bank forgives it, it's as if the bank just handed you $500,000, so the IRS and the state want a cut.
There are other types of phantom income that can incur a tax despite the fact that you've gotten no cash. However, COD income ranks near the top of my list of little understood tax traps. The good news is that there are exceptions and exclusions from tax that may keep you from having to write a check to the IRS. So you are not caught off guard, here are some useful rules about COD income.
Loans that are forgiven as gifts aren't taxable. If your debt is canceled by a private lender—say a relative or friend—and the cancellation is intended as a gift, there is no income to you. While it's not income to you, if the lender forgives more than $17,000 in a year (the gift tax annual exclusion), it may count against his or her own lifetime exemption from the gift tax. That can make it best for these loans to be forgiven a little at a time.
There's an exception for the mortgage on your home. During the 2007 financial crisis, Congress cut back on the IRS’s ability to tax debt relief. Applying only to your principal residence, the Mortgage Debt Relief Act excluded as income any debt discharge up to $2 million (an amount that was cut back to $750,000 for 2021 to 2025). The Mortgage Debt Relief Act also covered loans and subsequent debt forgiveness for amounts borrowed to substantially improve a principal residence.
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The Act initially covered 2007 through 2010 and was eventually extended to 2020. Then, the Consolidated Appropriations Act extended the exclusion to cover 2021 through 2025. However, the maximum amount of excluded forgiven debt is now limited to $750,000. Not surprisingly, if your lender writes off some of your mortgage, you will have to reduce your basis in the residence by the amount of discharged debt that does not count as income to you.
Note that this special relief for forgiven mortgages isn't automatic; to take advantage of it you must file IRS Form 982, with the intimidating title, "Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)."
Bankruptcy discharges aren't taxable. If your debt is discharged when you're in bankruptcy as part of a court-approved bankruptcy plan, it isn't taxed as income to you. However, the amount of the discharged debt goes to reduce certain tax attributes, such as net operating losses or the basis of property. Once again, the rules are complicated and filing an IRS Form 982 is required.
If you're insolvent, you get a pass. Even if you are not in bankruptcy, if you are "insolvent" when your debt is discharged, there is no tax. Insolvency is a simple test meaning that your liabilities exceed your assets. To escape tax, your liabilities must exceed your assets by more than the amount of the debt discharged. Say you have $1,000 in assets and $2,000 in liabilities, so you're underwater to the tune of $1,000. If your bank forgives a $500 debt, it is not income because the amount forgiven is less than the amount of your insolvency.
Disputed debts are different. Some taxpayers argue that the debt was invalid in the first place so there can be no discharge of debt income. It can be a slick position where it works, either to claim that the entire debt was bad, or that part of it was. The IRS tends to read this exception narrowly, but there are some decided court cases that can help if you are in a pinch.
The argument is based on the notion that a discharged debt is not income if the taxpayer contests the original amount of the alleged debt in good faith. In Preslar v. Commissioner, 2167 F.3d 1323 (10th Cir. 1999), the court stated that a subsequent settlement of a disputed debt is treated as the amount of debt for tax purposes. In other words, the excess of the original debt over the amount determined to have been due can be disregarded in calculating gross income.
Thus, a write down of a $1M debt to $400k usually causes $600k of COD income. But if the debt was disputed, and borrower and lender agree that only $400k is due, it might be different. Be careful, though. The IRS is alert to arguments that a debt was disputed when it looks like there really was no dispute that only time the taxpayer mentioned a dispute is when it came tax time.
Price adjustments are also not income. There is no income if an individual purchases property and the seller later reduces the price of the property. The purchaser's basis in the property, however, is reduced by the amount of the adjustment. These days this exception can be particularly important. Say you bought a rental unit five years ago for $500,000 from the bank, and still owe the bank $400,000. The unit is now worth only $350,000. The bank agrees to reduce the debt by $50,000. If this is just debt discharge, it's COD income. But if it is written as an adjustment to the purchase price, it's not.
Certain forgiven student loans aren't income. Another exception protects forgiveness of certain student loans. In the past, the IRS rules about taxing student debt relief hinged on the nature of the relief and who was getting it. Thus, traditionally, students who had their debts forgiven because they worked a certain term for public agencies were generally home free. In more recent times, the federal tax rules have gotten more liberal.
Before 2021, student debt cancelation was generally considered a form of income, and therefore taxable both at the federal and usually state level. But in March of 2021, the American Rescue Plan changed that. Until the end of 2025, the U.S. government will not consider canceled student loan debts to be taxable income. Thus, President Biden's sweeping student debt relief is not subject to federal income tax.
However, in some states—notably including California—borrowers may have to pay state income tax on all those canceled loans. California has a bill pending to change that, but it does not appear to have passed yet.
There's an exception for deductible interest. There is no income from cancellation of deductible debt. That means if a lender cancels home mortgage interest (interest only, not the principal of the debt), and that interest could have been claimed as a deduction on your tax return, there is no taxable income to the borrower.
Be Alert for IRS Form 1099-C. No one likes receiving an IRS Form 1099. In general, businesses must issue the forms to any payee (other than a corporation) who receives $600 or more during the year. That's just the basic threshold, but there are many exceptions. That's why you probably get a Form 1099 for every bank account you have, even if you earned only $10 of interest income. The key is IRS's matching.
Every Form 1099 includes the payer's employer identification number and the payee's Social Security number. The IRS matches Forms 1099 with the payee's tax return. There are lots of kinds of them, and there is one for COD income too. The IRS provides a list of lenders that must report using a Form 1099-C. It includes lenders who are regularly engaged in the business of lending money like banks, credit unions, credit card companies and any entity whose significant trade or business is the lending of money.
If you receive a Form 1099-C and disagree with the amount shown, write the lender requesting that it issue a corrected Form 1099-C showing the proper amount of canceled debt. If you believe the canceled debt isn't income to you because you're insolvent or for any other reason, don't ignore the 1099-C. Instead, you will need to address it on your tax return, explaining why it isn't taxable. And you may need a tax opinion and/or disclosure on your tax return.
FAQs
What are exceptions to recognizing income from the cancellation of debt? ›
EXCEPTIONS to Cancellation of Debt Income:
Amounts canceled as gifts, bequests, devises, or inheritances. Certain qualified student loans canceled under the loan provisions that the loans would be canceled if you work for a certain period of time in certain professions for a broad class of employers.
How to report the bankruptcy exclusion. To show that your debt was canceled in a bankruptcy case and is excluded from income, attach Form 982 to your federal income tax return and check the box on line 1a.
Does cancellation of debt affect your tax return? ›Generally, if you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.
When can a taxpayer exclude all income from their cancelled debt? ›Discharged debt is excluded from gross income if the discharge occurs when the taxpayer is insolvent. For purposes of the exclusion, insolvency is defined as the amount in which the taxpayer's liabilities exceed the taxpayer's assets. The amount excluded by an insolvent taxpayer is limited to the amount of insolvency.
Which of the following is an exception and not considered cancellation of debt? ›According to the IRS, the following are not considered cancellation of debt income: Debts canceled as gifts or inheritance. Some qualified student loans that meet specific criteria. Other education loans or relief programs that help provide health services.
How much tax do you have to pay on forgiven debt? ›When you take out a loan, you don't have to pay income taxes on the proceeds. The IRS does not consider borrowed money to be income. If the creditor cancels the loan, with some exceptions the amount of the forgiveness usually does become income. Then the forgiven debt is subject to taxation at your regular tax rate.
What is the tax rate for a 1099c? ›As a 1099 earner, you'll have to deal with self-employment tax, which is basically just how you pay FICA taxes. The combined tax rate is 15.3%.
What is the statute of limitations on IRS debt cancellation? ›Yes, after 10 years, the IRS forgives tax debt.
After this time period, the tax debt is considered "uncollectible". However, it is important to note that there are certain circumstances, such as bankruptcy or certain collection activities, which may extend the statute of limitations.
The Fresh Start program is open to any taxpayer who owes taxes and is struggling to pay them. There are no income requirements. The first step in applying for the IRS Fresh Start program is to contact your tax attorneys or accountants and see if you qualify.
Is the IRS forgiving tax debt 2023? ›What is the IRS Forgiveness Program? 2023 Updates. Certain taxpayers in the United States who cannot afford to pay their tax liability due to financial hardship may qualify for tax debt relief under the IRS Forgiveness Program.
How much will the IRS usually settle for? ›
How much will the IRS settle for? The IRS will typically only settle for what it deems you can feasibly pay. To determine this, it will take into account your assets (home, car, etc.), your income, your monthly expenses (rent, utilities, child care, etc.), your savings, and more.
Will the IRS catch a missing 1099 C? ›Any 1099 form you receive is also reported to the IRS. If you forget to report the income documented on a 1099 form, the IRS will catch this error.
What type of debt Cannot be erased? ›Key Takeaways. Types of debt that cannot be discharged in bankruptcy include alimony, child support, and certain unpaid taxes. Other types of debt that cannot be alleviated in bankruptcy include debts for willful and malicious injury to another person or property.
Does a 1099 C hurt you? ›If you receive a 1099-C, you may have to report the amount shown as taxable income on your income tax return. Because it's considered income, the canceled debt has tax consequences and may lower any tax refund you are due.
Do credit card companies ever forgive debts? ›Credit cards are another example of a type of debt that generally doesn't have forgiveness options. Credit card debt forgiveness is unlikely as credit card issuers tend to expect you to repay the money you borrow, and if you don't repay that money, your debt can end up in collections.
What are the impacts of debt cancellation? ›The immediate effect is that it reduces future interest and principal payments, which is revenue for the federal budget. Debt cancellation therefore leads to a sudden decline in expected net revenues, all else equal, which becomes insufficient to back the outstanding level of debt.
What is debt cancellation policy? ›A debt cancellation contract (DCC) cancels all or part of a loan due to a change in circumstances for the borrower. Banks and other financial institutions offer debt cancellation contracts in place of credit insurance plans. DCCs place the onus of risk on the issuing agency, which often benefits borrowers.
Why do you have to pay taxes on forgiven debt? ›The US tax codes require you to add any forgiven debt as an income and have it taxed because you received a particular benefit without paying for it.
Is COVID loan forgiveness taxable? ›Borrowers must meet requirements for PPP loan forgiveness
The program's purpose was to help businesses keep their workforce employed during the crisis. If taxpayers meet certain requirements, the loans are forgiven. Generally, forgiven loans are taxable as discharge of debt income.
In most situations, if you receive a Form 1099-C, "Cancellation of Debt," from the lender that forgave the debt, you'll have to report the amount of cancelled debt on your tax return as taxable income.
Who is eligible for 1099c? ›
File Form 1099-C for each debtor for whom you canceled $600 or more of a debt owed to you if: You are an applicable financial entity. An identifiable event has occurred.
What happens if I don't file my 1099c? ›If you don't report the taxable amount of the canceled debt, the IRS may send you a notice proposing to assess additional tax and may audit your tax return. In addition, the IRS may assess additional tax, penalties and interest.
Is there a one time tax forgiveness? ›One-time forgiveness, otherwise known as penalty abatement, is an IRS program that waives any penalties facing taxpayers who have made an error in filing an income tax return or paying on time. This program isn't for you if you're notoriously late on filing taxes or have multiple unresolved penalties.
Does the IRS forgive tax debt? ›The IRS will rarely forgive your tax debt. Deals such as “offer in compromise” are only extended to those experiencing genuine financial hardship, such as a catastrophic health care emergency or a lost job paired with poor job prospects.
What happens if you owe the IRS more than $25000? ›Taxpayers may still qualify for an installment agreement if they owe more than $25,000, but a Form 433F, Collection Information Statement (CIS), is required to be completed before an installment agreement can be considered.
What is the IRS hardship program? ›The IRS may agree that you have a financial hardship (economic hardship) if you can show that you cannot pay or can barely pay your basic living expenses. For the IRS to determine you are in a hardship situation, the IRS will use its collection financial standards to determine allowable basic living expenses.
What is the 2023 IRS Fresh Start Program? ›What is the IRS Fresh Start Program? The IRS Fresh Start Program is designed to help taxpayers who have accumulated a substantial federal tax debt that exceeds their capacity to pay. By applying and meeting eligibility criteria, taxpayers can substantially decrease their outstanding federal tax liabilities.
How much is the IRS Fresh Start Program? ›There can be various setup and application fees associated with IRS Fresh Start tax relief. Offer-in-Compromise requires a $205 application fee, and setting up an installment agreement also involves costs. It's possible to have your fees waived if you qualify for the Low-Income Certification.
How do I ask the IRS for forgiveness? ›Use Form 843 to claim a refund or request an abatement of certain taxes, interest, penalties, fees, and additions to tax.
Is the IRS garnishing tax refunds 2023? ›The U.S. Department of Education suspended the seizure of tax refunds, child tax credits and Social Security and other government payments to cover money owed for defaulted student loans for 2022 and potentially much of 2023. Collection calls and billing statements will not be sent out. Interest will not add up.
What are the IRS changes for 2023? ›
The standard deduction also increased by nearly 7% for 2023, rising to $27,700 for married couples filing jointly, up from $25,900 in 2022. Single filers may claim $13,850, an increase from $12,950.
Can I negotiate with the IRS myself? ›You can talk directly to negotiate a deal with the IRS.
This is, however, the exception, not the rule, and is usually achieved when the IRS can easily determine additional collection efforts would produce no additional payments.
Generally, the IRS can't issue a tax levy until it sends out several written notices—generally four. It can take up to six months or even longer from the due date of your payment, until the IRS can legally levy on your bank account. The last of the IRS notices is known as a Collection Due Process Notice.
How to get a $10,000 tax refund? ›Individuals who are eligible for the Earned Income Tax Credit (EITC) and the California Earned Income Tax Credit (CalEITC) may be able to receive a refund of more than $10,000. “If you are low-to-moderate income and worked, you may be eligible for the Federal and State of California Earned Income Tax Credits (EITC).
Can a creditor collect on a Cancelled debt? ›Sometimes, even when debt has been forgiven, the lender may not have reported it to the credit-reporting bureaus. The debt may have even been sold to a debt collector. If this happens the creditor may have no legal right to collect once the debt has been forgiven and a Schedule 1099-C issued.
How long does a creditor have to send a 1099-C? ›You will not have to pay this back, but you may have to claim it as taxable income to the IRS. However, in 2016, an IRS rule allowed debt collectors to file a 1099-C after 36 months of no payment. In this event, the account is still delinquent, but the debt hasn't been forgiven, so the lender may still try to collect.
Can I ignore 1099-C? ›It's unwise to ever ignore a canceled debt, or receipt of a 1099-C, especially since the IRS expects to have that specific income included within your return – unless there is an exclusion or exception. You should also track canceled debt, even if you didn't receive a 1099-C.
Which deletes the debt completely? ›Chapter 7 bankruptcy is a legal debt relief tool. If you've fallen on hard times and are struggling to keep up with your debt, filing Chapter 7 can give you a fresh start. For most, this means the bankruptcy discharge wipes out all of their debt.
Who Cannot pay debt? ›'A person who is unable to pay his/her debt is called a 'bankrupt. '
At what point does a debt become uncollectible? ›In California, the statute of limitations for consumer debt is four years. This means a creditor can't prevail in court after four years have passed, making the debt essentially uncollectable.
Do I have to pay taxes on cancelled debt? ›
In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.
Is cancellation of debt bad? ›Unless debt cancellation comes in the form of bankruptcy or debt settlement, cancellation of debt doesn't always impact your credit score. However, debt cancellation may not be all good news for you. In some cases, you may have to pay taxes on canceled debt, as the government may consider it taxable income.
Can I buy a house with a 1099a form? ›1099-A must be filed by the lender when the loan was made in relation to his trade or business, even if that business is not finance-related. The lender must also send a copy of the completed form to the borrower as long as he can be traced. The form is always needed for real property such as a house.
Is it true that after 7 years your credit is clear? ›Most negative items should automatically fall off your credit reports seven years from the date of your first missed payment, at which point your credit scores may start rising. But if you are otherwise using credit responsibly, your score may rebound to its starting point within three months to six years.
How much is tax on forgiven debt? ›When this happens, the IRS won't tax the canceled debts as income. Your forgiven debt includes tax-deductible interest. If a lender forgives a business loan or mortgage, you don't need to report the interest as income because it would have been deductible anyway.
Is credit card debt forgiven at death? ›No, when someone dies owing a debt, the debt does not go away. Generally, the deceased person's estate is responsible for paying any unpaid debts. When a person dies, their assets pass to their estate.
What are the exceptions to cod income? ›Not all COD income must be included in gross income. There are several exceptions: If the discharge of indebtedness occurs in a Title 11 case—i.e., a bankruptcy. If the discharge of indebtedness occurs when the taxpayer is insolvent.
In what instance is no taxable income is recognized in a cancellation of debt? ›Even if you receive a Form 1099-C from a lender, you still may be able to avoid taxation on the forgiveness of a debt. If your debt was discharged in a Title 11 bankruptcy proceeding, such as a Chapter 7 or Chapter 13 case, you're not responsible for taxes on that debt.
In what circumstance can an installment debt be excluded from a borrower's obligations? ›Debts Paid by Others
When a borrower is obligated on a non-mortgage debt - but is not the party who is actually repaying the debt - the lender may exclude the monthly payment from the borrower's recurring monthly obligations.
If you know you have a canceled debt of over $600 but you didn't receive a 1099-C, it's still your responsibility to include the forgiven debt on your federal tax return. Just because your lender failed to file a 1099-C doesn't mean you can get away with not reporting your debt on your taxes.
What does income exception mean? ›
The income exclusion rule sets aside certain types of income as non-taxable. There are many types of income that qualify under this rule, such as life insurance death benefit proceeds, child support, welfare, and municipal bond income. 1 Income that is excluded is not reported anywhere on Form 1040.
What are four examples of exceptions that allowable when one wants to avoid taxation on unrelated business income? ›For example, dividends, interest, certain other investment income, royalties, certain rental income, certain income from research activities, and gains or losses from the disposition of property are excluded when computing unrelated business income.
Why is debt forgiveness taxable? ›The US tax codes require you to add any forgiven debt as an income and have it taxed because you received a particular benefit without paying for it.
Does the IRS have a debt forgiveness program? ›The IRS Debt Forgiveness program provides relief to taxpayers who can't pay their taxes in full. The program allows forgiveness for some or all of the liability. Forgiveness is at the discretion of the IRS based on specific criteria, such as income level and ability to pay.
What is the black hole cancellation of debt income? ›“Black hole” CODI: If the debtor consolidated group's CODI exceeds the amount of attributes of the group, this excess CODI generally is referred to as “black hole CODI.” Black hole CODI generally means that the taxpayer can exclude the CODI from taxable income without any corresponding reduction in attributes.
Does car payment count as debt? ›The auto loan itself would be considered the "debt." The payments toward it would be considered "debt payments." With regard to your credit report, if you are applying for another loan somewhere and they looked at your debt-to-income ratio, the monthly auto loan payments would be included on the debt side.
What excluded debt means? ›The Personal Insolvency Act 2012 specifies certain types of debt that cannot be written off by a Debt Relief Notice. These are called excluded debts. The Act specifies certain other types of debt that are excludable from a DRN.
What if I filed my taxes and then received a 1099c? ›If you receive a 1099-C, you may have to report the amount shown as taxable income on your income tax return. Because it's considered income, the canceled debt has tax consequences and may lower any tax refund you are due.
Will the IRS catch a missing 1099-C? ›Any 1099 form you receive is also reported to the IRS. If you forget to report the income documented on a 1099 form, the IRS will catch this error.
Do all creditors file 1099c? ›If a debt is owned (or treated as owned for federal income tax purposes) by more than one creditor, each creditor that is described under Who Must File, earlier, must issue a Form 1099-C if that creditor's part of the canceled debt is $600 or more.