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Does the IRS Declare Forgiven Debt Taxable?

When a person cannot manage or make payments on their debt, they might seek assistance through debt settlement. According to the New York Federal Reserve, consumer debt reached $14.56 trillion in the last couple months of 2020.

Debt settlement is an option for those with overwhelming amounts of dues, and individuals will seek professional help negotiating how much they can pay for what they owe. Realistically, this process can take some time and may not completely erase the debt.

Ensuring that you have proper representation and that your negotiations are fair and just is the job of your tax resolution attorney. Legal professionals understand the complex workings of loan forgiveness and can help you provide the necessary documentation for your case.

How Does Debt Settlement Work?

Debt forgiveness attorneys support and negotiate consumers’ debts down with either the original lender or a collections agency. The lenders are not obligated to accept the debt settlement proposals; more often than not, this allows individuals to have a better chance of paying off the debt through an agreement. If a person has a significant chunk of debt canceled, the IRS will tax the forgiven amount.

Reporting Your Forgiven Debt to the IRS

If the forgiven debt is over $600, then taxes are taken from the amount settled. To report this information to the IRS, creditors will submit a 1099-C form that declares the total debt canceled. When the final payments are made, a copy of the form is sent. According to the IRS, the following list states examples of when a 1099-C cancellation of debt form is used:

  • The debtor agrees on whether to settle a debt and not collect it

  • Debtor is unable to or gives up collecting the legitimate debt

  • The debtor surrenders property to the lender, but the value doesn’t cover the total amount owed

  • There’s a modified mortgage because of the inability to pay

  • The debtors’ property is foreclosed or repossessed, but the value can’t cover the total amount you owed

It’s important to note that while you will be taxed depending on the amount and type of debt, there are some exceptions to this rule.

When Is Your Canceled Debt Exempt from Taxes?

Whether student loans or auto loans, most individuals in the United States have a significant amount of debt. For those looking for options in loan forgiveness, debt settlement is often a last resort. If a lender agrees with the proposal and the debt forgiven is a significant amount, the IRS will collect taxes on the new income.

However, there are some cases where the IRS states a creditor does not need a 1099-C form. Some of these include:

  • Debts canceled through inheritance or as a gift

  • Certain credits provided by property buyers

  • Certain canceled student loans

  • Specific reductions under the Home Affordable Modification Program

The debts above are not considered taxable income. When deciding what to include in your 1099-C documentation, make sure to work with an experienced tax resolution attorney.

Learn How a California’s Tax Resolution Attorney Can Help

If you’re working on submitting a debt settlement and need experienced tax professionals, attorney Becky Sebastian of Morgan Sebastian Law can provide you with the tools and guidance you need for a fair and just agreement. Understanding the laws and procedures behind legal matters can easily cause misunderstandings but having proper legal representation will assist and advocate for your rights.

Learn more about how our team can assist you or schedule a consultation by filling out our online contact form or call 877-938-1350.