Many Americans take on debt to pay for education, buy houses, cars, and other expenses. But you may find yourself with more debt than you can handle due to unemployment, health issues, or just life in general. In this case, having your debt forgiven could be a relief, but it may affect your taxes.
What is forgiven debt?
The lender of the credit or loan may choose to forgive or discharge your debt for less than the full amount you owe. The forgiven amount of debt is considered canceled. The lender can choose to erase the debt either completely or partially.
How the IRS classifies forgiven debt
The IRS classifies forgiven debt as taxable income because you never paid it back. Think of getting a loan as entering into a contractual agreement. If the contract gets canceled without you paying back the loan, then this is considered taxable income.
But, if you had debt forgiven in the event of bankruptcy, then you don’t have to pay taxes on the debt. Canceled debt must be reported on your tax return the year the cancellation occurs.
What is Form 1099-C?
If your debt is worth more than $600, you will receive Form 1099-C from the lender in the mail. This form is used to report the amount of debt the lender forgave. You will then use Form 1099-C to file your tax return.
Note: If you do receive this form, be sure to check it for accuracy. If there are discrepancies, contact the organization collecting the debt.
Are there any exceptions?
Yes, the law makes some exceptions. Debt that has been erased for any of the following reasons is not taxable:
- Amounts canceled as gifts, bequests, devises, or inheritances
- Certain qualified student loans canceled under the loan provisions that loans would be canceled if you work for a certain period in certain professions for a broad class of employers
- Certain other education loan repayment or loan forgiveness programs to help provide health services in certain areas
- Amounts of canceled debt are deductible if you, as a cash basis taxpayer, paid it
- A qualified purchase price reduction given by the seller of property to the buyer
- Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program
- Amounts from student loans discharged on the account of death or total and permanent disability of the student
You can also exclude debt from your gross income depending on your financial circumstances. Learn more
Mortgage Forgiveness Debt Relief Act
In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act in response to the real estate market crash. For calendar years 2007 through 2017, you could exclude up to $2 million in forgiven mortgage debt if you were married and filing jointly (or up to $1 million for other filing statuses). This exclusion also applies to debt that was discharged in 2021 if there was a written agreement that entered into 2020.
The Consolidated Appropriations Act (CAA) was signed into law to provide relief to those affected by COVID-19. The CAA allows taxpayers to exclude up to $750,000 of qualified mortgage debt for tax years 2021 through 2025.
If you have canceled debt to report, TaxSlayer can help you with your tax return. Get started for free today!
