A contractor friend of mine called me up the other day, frantic about something he’d received from a debt collection agency. He had never gotten a 1099-C before, and the instructions said he was going to have to REPORT nearly $50,000 extra in taxable income on this year’s tax return for something that happened 20 years ago. He called me because I’m his realtor and the debt involved a home he had owned with his ex-wife.
This topic gets pretty complicated, and could raise your blood pressure. If you stop reading here, however, just take these few points away with you:
- If you receive a 1099-C, you need to file an IRS Form 982.
- There are some exceptions where the forgiven debt is non-taxable.
- If you or someone you know is currently facing bankruptcy or foreclosure, that may not be the kind of relief you think it is. Try to avoid foreclosure. There are other options for you (like letting Hermit Haus Redevelopment, LLC help).
Lenders who forgive a debt of at least $600 must send a 1099-C to the debtor by January 31 following the year in which the forgiveness occurred. The amount of debt cancellation appears in Box 2 of Form 1099-C. If the amount is indeed taxable income, it must be reported on the income tax return filed for that year.
Qualified Principal Residence Indebtedness
You can exclude canceled debt from income if it is qualified principal residence indebtedness. Qualified principal residence indebtedness is any mortgage you took out to buy, build, or substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to buy, build, or substantially improve your main home, but only up to the amount of the old mortgage principal just before the refinancing.
How to report the qualified principal residence indebtedness exclusion. To show that all or part of your canceled debt is excluded from income because it is qualified principal residence indebtedness, attach Form 982 to your federal income tax return and check the box on line 1e. On line 2 of Form 982.
The Deal with Collection Agencies
It seems that some debt collection companies purchase old debts, mark them up with incredibly high penalties and fees, then “forgive” them and write them off as tax losses and send the debtors 1099-C forms—which means you have to pay taxes on the forgiven amount.
Now, years later, your financial situation may have changed for the better. You might have to pay income tax on the forgiven debt just as if you had “earned” the forgiven debt as income this year.
The new creditor (the collection agency) has to have engaged in significant, bona fide collection activity at any time during the 12-month period ending at the close of the calendar year. Robo-dialing and automated mailing don’t constitute “significant, bona fide collection activity” for this purpose.
Some Considerations for Disputes
How do you know what the collection agency actually paid for the debt? They’ve paid pennies on the dollar for this debt. They’ve made money. How is the “forgiven amount” calculated? Do you use the original amount of the debt with the creditor or what the collection agency paid for it? With the horrendous shape the collection agencies records typically are, it would be tough for them to prove ANY relationship between themselves and the original creditor.
The IRS has a process in place for dealing with this situation. Ironically, they don’t provide this form on their website. To deal with this errant 1099-C, consumers should:
- Call the IRS (1-800-829-1040 ) and have an IRS representative initiate a Form 1099 complaint.
- The IRS will fill out form 4598, “Form W-2, 1098, or 1099 Not Received, Incorrect or Lost.”
Here’s My Question:
Every state has its own statute of limitations that determines when you can no longer be sued for old debt; however, the FTC says that doesn’t prevent collection agencies from attempting to collect time-barred debt provided they don’t harass you or engage in anything illegal. Collection companies aren’t allowed to collect more than the original debt, “unless your state law permits such a charge.” Debt included in a bankruptcy can’t be collected at all.
Does anyone know the laws in Texas regarding this specific activity?
For further reference: