1099-C-U-Later - Avoid a Raw Tax Deal on Chapter 7 Discharged Debt

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The whole point of filing bankruptcy is to get a financial clean slate, right? But even if your Chapel Hill bankruptcy attorney filed your chapter 7 bankruptcy to a tee, there can still be some debt dilemmas you have to clean up to avoid some unwanted tax consequences. If you think debt collectors are a pain, you won’t want to deal with IRS collections – I promise you they are even worse! So what can cause the tax dilemma of which I speak? An improperly issued Form 1099-C!

What Is a Form 1099-C and Why Was I Sent One?

A 1099-C is a Cancellation of Debt notice. When you have debt discharged this is typically issued. For instance, if you have a $2,000 credit card bill you can’t pay and you work out a settlement with your lender to pay just $1,000 to clear the debt, they will usually send a 1099-C to you and the IRS for the $1,000 of debt they wrote off. For any debt discharged that is greater than $600, a 1099-C is normally issued – particularly by large companies like credit card and auto finance firms. This is the standard practice but won’t result in a taxable event for debts discharged in a chapter 7.

Why Is My Forgiven Debt Taxable?

The IRS loves to create opportunities to tax – I am always stunned by the new and inventive ways they develop taxation tools – and debt forgiveness is one. The IRS likes to assess taxes based on implied income. Basically, in the scenario above, you get rid of $1,000 in debt you would otherwise have to pay. Because you owed it and now don’t have to pay it, it effectively bumped your income by $1,000 (not in my mind, but in the “tax everything” mindset of the all-powerful IRS).

What stinks is that if you are in a circumstance where you have to beg for a deal like this, you’re likely cash-strapped and don’t need any added tax burden to make your situation worse. But if your debts are discharged in bankruptcy, the taxable 1099-C scenario should not come in to play.

Why Is My Bankruptcy Discharged Debt Not Taxable?

The simplest answer is that the laws are different for debts resolved under Title 11 of the US Code. You don’t need to know the details. just know that bankruptcy protects you both from firther debt collection efforts as well as from any tax consequences associated with discharge! But just because you won’t owe taxes on discharged debt doesn’t mean you won’t see a 1099-C issued. Some companies may have it set in their system to auto-issue one with a certain format. If you get one in the mail and it’s not completed properly, you need to take action.

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What Should I Do if I Was Sent a 1099-C for Bankruptcy Discharged Debts?

If you get a 1099-C any time between when your debts were discharged in bankruptcy up until when you file your taxes, here’s how I recommend you proceed if it’s not correct. If you get a 1099-C, look in box six and make sure you see code “A” (see green arrow on form above). If there is no A, or there’s another letter there, you need to take corrective steps!

First, the IRS says (and I concur) that your first line of defense is to contact the lender. Reach out to the creditor and let them know they improperly issued a 1099-C because the discharge was in bankruptcy and should be coded in box six with an “A”. You’ll likely have to provide your bankruptcy case number and other info. If they act properly, they will re-issue the 1099-C with the correct code.

Image source: IRS.gov

If they fight you on it, don’t sweat, I’ve got another alternative for you. You’ll need Form 982 – click here for the 2013 revised form – and your 1099-Cs in hand to complete it. Up in part I of the form (see the red arrow above), check box A “Discharge of indebtedness in a title 11 case.” Title 11 covers chapter 7 and 13 consumer bankruptcies. Then on line 2 (see the blue arrow below), put the total of all 1099-Cs you got related to bankruptcy debt discharge (whether or not they properly reflect code A in box six). That’s it. For a tax form, I find this shockingly not-so-complicated! Attach copies of the 1099-Cs to go along with this and submit all with your Form 1040.

Image source: IRS.gov

How Do I Get Started with a North Carolina Bankruptcy Filing?

One of the best things about filing a chapter 7 bankruptcy is the tax benefit of having your debts discharged without paying additional taxes. If you are neck-deep in debt and in desperate need of a financial fresh start, contact a reputable North Carolina bankruptcy attorney like John T. Orcutt. Our law office offers a free consultation and, if you qualify, can get you started on a zero down bankruptcy plan. Contact us today for an appointment.