If you thought you’re done with your money woes when you settled that credit card debt, think again. If a creditor writes off the debt you owe or lets you settle a debt for less than the full amount, guess who’s going to come knocking? You guessed it, the taxman!
Months after resolving a credit card debt, debtors may soon find themselves receiving a 1099-C (cancellation of debt) tax notices in the mail. How so, you may ask? Here’s how it works:
Creditors often write off debts after a set time period, like a year after you default for instance. Once debt is written off, the creditor ceases all collection efforts, declares the debt uncollectible, and reports it to the IRS as lost income to reduce its tax payables. As you can imagine, the IRS will still want to collect its money, so instead of chasing your creditor, the agency will set its sights on you.
Since you no longer have to pay your debt’s full amount, the IRS considers this as gained income for which you need to pay for the corresponding income taxes.
Still, all is not lost. You could still qualify for some type of tax relief. Learn more about your options by talking to a knowledgeable tax lawyer in your area.