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  5. Video: Debt Cancellation and Your Taxes Explained

Video: Debt Cancellation and Your Taxes Explained

Updated for Tax Year 2020 / May 3, 2021 09:28 PM


OVERVIEW

Having your debt cancelled may square you with your creditor, but that debt may still be taxable. This video will help you determine whether you need to report your cancelled debt to the IRS.


Video transcript:

Hello, I'm Jill from TurboTax with some important information for taxpayers who received a 1099-C form this year.

Not sure why you received a 1099-C form or what you should be doing with the information? The reason you received it is because one of your creditors decided to cancel or forgive a debt you owe them, and you may need to report it on your tax return. But you can't make this determination without considering other factors first.

Believe it or not, your cancelled debt may be taxable. For example, if you have a credit card balance of $10,000 but are successful in negotiating with your credit card company to reduce it to $6,000 in exchange for immediate and full payment, the credit card company must report the $4,000 of canceled debt on a 1099-C. They'll send you a copy of the form by January 31 in the year after it cancels the debt.

Typically, you will need to report this $4,000 as income on your tax return. But depending on the type of debt that's cancelled, there are a number of exceptions and exclusions to this rule.

If your student loans are cancelled because of your employment with the federal government, none of this canceled debt is taxable. And if the debt you fail to pay would be deductible had you paid it, the cancellation is not taxable either. An example of this is when you fail to pay a bill, which is eventually cancelled, that would otherwise be a deductible business expense if you paid it.

Exclusions can also be granted when the debt cancellation is the result of a bankruptcy or if it occurs at a time when you're insolvent, meaning you have more debts than assets at the time your creditor forgives the debt.

There is also a special exclusion that applies to the mortgages you have on your main home (but only through 2020). If your mortgage lender cancels some of your outstanding debt, regardless of the amount, you don't have to report it on your tax return in most cases.

Given all of the ways you can avoid reporting your 1099-C on your tax return, it's important to think about whether you are eligible for one of the exclusions and exceptions. The last thing you want to do is report more income on your tax return than you need to.

When you file your taxes with TurboTax, we'll ask you simple questions and determine which forms you need to include with your tax return.

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