If you are considering whether to file bankruptcy or use debt management understand that paying your debt in part only leaves you with a 1099 and an IRS tax debt that is often worse than owing the debt.
An income tax form called the 1099 C forgiveness of debt is reported as income to you in the year the debt was written off. A creditor is required to issue an income tax IRS 1009 C to any person that settles a debt or has a debt written off in excess of $600. Try to settle a debt for less than payment in full and have an income tax bill. If you use a debt management firm to settle your debts don’t be surprised when the 1099 C comes in the mail. If you do a short sale on a house in foreclosure and the bank was not paid all the money look out for a 1099 C. If there was a balance left on the mortgage after your property is sold at foreclosure or by a short sale. The mortgage company will issue you a 1099 C for the difference.
Reporting forgiveness of debt on the IRS 1099 c is required to be issued by any creditor that settles or writes off over $600. If you settle your $10,000 debt for $3000 you will get a 1099 c for $7000 and and a tax bill of about 2,000 – 3,000. If you don’t declare this income you will also get non reporting and negligence penalties.
There are 2 exceptions to the 1099 C forgiveness of debt. The first is you are insolvent when the debt is written off (bankrupt). The second is you file bankruptcy before the debt is written off and the 1099 c is issued, there is also no income to declare. If you file bankruptcy after the 1099 C is issued you still have to declare that as income. There is a third exception for real estate. It is the Mortgage Forgiveness Act of 2007. It apples to the homeowners of residential real estate only. It also only applies to homeowners who had the debt written off during 2007 to 2012.
