Charged-Off Credit Card Debt Coming Back to Bite Taxpayers
Some of the billions of dollars in credit card debt that was charged-off during the Great Recession is coming back to bite consumers who benefitted from forms of credit card debt relief, such as debt cancellation, debt forgiveness, and debt settlement services.
Many debtors don’t realize that as soon as they breathe a sigh of relief after their creditors agree to cancel, forgive, or settle some of their credit card debts for less than what was owed — often gained with the help of a professional debt relief service — they need to switch gears and prepare to pay taxes on the portion of forgiven debt.
The IRS, which counts cancelled and forgiven debts as income in most cases, requires that creditors send 1099-C tax forms to debtors who have had a portion of their debts forgiven. The IRS projected that creditors will send taxpayers 6.4 million 1099-C forms in 2012, up from 3.9 million in 2010.
Gerri Detweiler, a personal finance expert for Credit.com, said that the increase in 1099-C forms is due to the rise in credit card defaults during the recession, which, according to Moody’s Investor Service, resulted in $75 billion in write-offs among the nation’s six largest credit card companies in 2009 and 2010.
The only way to avoid liability for a tax bill associated with cancelled debt is to prove that the debt was discharged in bankruptcy or that the taxpayer was insolvent when the debt was written off, according to Jennifer MacMillan, an enrolled agent in Santa Barbara, Calif (“Canceled Credit Card Debts Come Back to Haunt Taxpayers,” Detroit Free Press, March 5, 2012).
Because some of the cancelled debts that the IRS is collecting taxes on can be decades old, it’s important to keep written records of cancelled, forgiven, or settled debts for extended periods of time. Additionally, many 1099-C forms contain errors, sometimes due to recordkeeping issues that can frequently arise from old debts. According to Nina Olson, an IRS Taxpayer Advocate, Treasury Department regulations encourage creditors to file 1099-Cs for debts they haven’t tried to collect on in 36 months or more, even if the debts haven’t been forgiven. And sometimes, taxpayers will receive duplicate forms for the same debt.
The number of 1099-Cs will rise even more if a tax debt relief law that gives homeowners an exemption to avoid the income tax burden on cancelled mortgage debt is allowed to expire this summer. The law was enacted in 2007 to help homeowners caught in the mortgage crisis avoid an income tax penalty for homes that received mortgage debt relief or ended up in a short sale or foreclosure.
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