When a lender eliminates the borrower’s obligation to repay a debt, the amount of that forgiven debt is considered taxable income. There are five principal exceptions to this rule, however. The exceptions include a mortgage on a principal residence, bankruptcy, insolvency, farming activity debt and no-recourse loans. If an exception applies, filing Form 982 with a tax return allows a taxpayer to report the 1099-C income as nontaxable income.
Lenders who forgive a debt of at least $600 must send a 1099-C to the debtor by Jan. 31 following the year in which the forgiveness occurred. The amount of debt cancellation appears in Box 2 of Form 1099-C. If the amount is indeed taxable income, it must be reported on the income tax return filed for that year.
Debt Forgiveness: Student Loans
There are situations where the cancellation of debt applies to student loans. Student loans are long-term commitments. Loans issued by a government entity, a public benefit corporation or a school with programs that encourage service in underserved fields or populations are subject to forgiveness. An agreement to serve in an approved occupation for a specified period could result in the cancellation of student loan debt. Student loan debt will cause a 1099-C to issue and the stated amount must show on your income tax return as taxable income for the year of cancellation. You can avoid this if you fulfill the terms of your loan agreement that requires you to work in a certain field for a specific amount of time. You must complete and file Form 982 with your income tax return.
Bankruptcy and Insolvency
Insolvency is the reason for many bankruptcy filings. This is when the value of assets is less than the total of your debts. When a Title 11 bankruptcy discharges these debts, a 1099-C will be issued as a declaration of taxable income. You can complete Form 982 and attach it to your income tax return. Document the insolvency issue on Form 982 in Section 1082. The amount you wish to exclude from income can be either the amount of debt forgiveness or the amount of insolvency, whichever is smaller.
Whether voluntary or involuntary, vehicle repossession may result in taxable income. One exception involves the discharge of debt in a Title 11 Bankruptcy. Lenders try very hard to avoid negotiations that result in issuance of a 1099-C. They will hold you responsible for payment of any loss resulting from the sale of the vehicle at auction. If you do obtain cancellation of this remainder debt under the provisions of Title 11, you will receive a 1099-C. Therefore, the remainder debt becomes taxable income. Form 982 will not exclude this debt from your income.