What is Federal Form 1099-C?

Do not be surprised when months after you have made a settlement with one of your creditors a letter arrives from the credit card company containing a Form 1099C.

The Internal Revenue Code provides that when banks and some credit card companies “forgive” or “discharge” more than $600.00 of a person’s indebtedness they must send a Form 1099-C to the Internal Revenue Service, with a copy to the taxpayer, advising them of the amount discharged. The savings, which is the difference between what is owed and the amount of the settlement, is treated by the IRS as “Income from Discharge of Indebtedness” (IRS Code S.108). For example, if you owe $5,000 to the Bank of America and settle the debt for $2,000 you will receive a 1099-C from the Bank of America for $3,000. This does not mean that you owe the Bank of America $3,000, it simply means that this is the amount of debt that was “forgiven” by the Bank. You do not owe this money to the Bank and they will not attempt to collect it from you. A person receiving a 1099-C is then supposed to report that amount as income on their Federal income tax return.

There is, however, one very important exception to this reporting requirement. If you were “insolvent” at the time the settlement was made then you do NOT have to report the amount stated in the 1099-C on your Federal Income tax return.
The term “insolvent” means that your liabilities (the amount that owe to all of your creditors) are equal to or exceed your assets. In order to figure this out you add up everything you owed just before the settlement. This includes the full amount of the debt before settlement, all mortgages, bank loans, automobile or other secured loans, credit card and all other bills or debts of any kind (even the $500 that you borrowed from a friend) and then add up the fair value of your assets at the time of the settlement. If the amount of your debts exceeds the value of your assets you are “insolvent” and you do not have to report the amount of the 1099-C on your income tax return. Be careful, however, since you do have to report savings that exceed your insolvency and this balance is taxable income. In other words, if you are “under water” by $5,000 (your liabilities exceed your assets by $5,000) and the settlement saved you $6,000 then you have to report $1,000 of income. If you ignore the 1099-C when you file your tax return for that year, you will get a friendly letter from the IRS the following year with a recalculation of your taxes and a demand for payment with interest.

How can you establish to the IRS that you were insolvent immediately before the discharge? You should file IRS Form 982 and a financial statement as of the day before the settlement that led to the 1099C. These have to be included with the tax return.

If your tax return was filed before you received the 1099-C or did not know what the 1099-C meant and now have to answer the IRS collection letter, we recommend the same. Check off the box on the IRS letter that asks if you have a defense, etc., enclose a letter saying that you were insolvent immediately before the discharge of indebtedness and enclose a balance sheet showing that your liabilities exceeded your assets.

It is important to keep a file when you settle any debt including your most recent bank statements, a list of assets and their fair market value that you own at the time of the settlement and the list of liabilities. If you own a car, for example, the Kelly Blue Book (available on the internet or at car dealer) should show its fair market value. This would go on the asset side of your or financial statement, and the amount you owe on the car would go on the liability side. Make sure you include all debts so that your insolvency will exceed the settlement savings.

Please note that this general guide is not intended to be specific tax advice nor should you rely upon it to the exclusion of consulting with a lawyer, accountant or other tax professional since each person’s tax situation is different.

DNS can provide you with a simple financial statement form and a copy of IRS Form 982 upon request.

If you have any general question about settling debt do not hesitate to call a DNS trained customer service representative.

Richard A. Savrann, Legal Counsel