If you’ve canceled a debt with a creditor (with their agreement) you may not save as much as you thought. If the debt was more than $600, you may owe taxes on it.

You’ll know if you owe taxes on the debt because the lender will send you a 1099-C. Like the 1099-MISC or any other 1099, you must claim the income on your taxes, which means an increased tax liability.

Why the IRS Cares About Canceled Debts

It may seem unfair. Why would the IRS care about a debt that you canceled? The IRS looks at it as income. You received something, whether a product or service, and you didn’t pay for it. The IRS considers this income and you must pay taxes on it.

When will you Receive a 1099-C?

All lenders should send you a 1099-C if they cancel your debt and it’s for more than $600. You may or may not receive one if you’re close to the limit. But, if it’s for any of the following, you’ll receive one:

  • Foreclosure
  • Car repossession
  • Voluntary repossession of an asset
  • Modification of a mortgage loan

Ways to Avoid the 1099-C

As with anything, sometimes you can avoid the 1099-C, such as:

  • Any mortgage debt discharged between 2007 – 2019 up to $2  million for married filing joint couples may be excluded
  • Any mortgage debt discharged between 2007 – 2019 up to $1 million for single filers may be excluded

The above pertains to any mortgage debt that lenders forgave or modified which resulted in forgiveness or principal reduction.

If you filed Chapter 7 or Chapter 13 bankruptcy, you may avoid taxation. You must prove the creditor canceled the debt while you were in the midst of the bankruptcy. If you can, you won’t owe taxes on the amount forgiven.

Disputing a 1099-C

If you receive a 1099-C but think it’s in error, contact the creditor immediately. For example, if you received the form, but the creditor still tries collecting the debt, they didn’t cancel it. If they didn’t cancel it, you don’t have canceled debt income and don’t owe taxes on it.

Since you received the tax form, though, you must report it on your taxes. Discuss the issue with the creditor right away to clear the air. Make sure you keep all communication in writing so you have written proof should tax issues arise.

What if you Don’t Receive a 1099-C?

If a creditor doesn’t send a 1099-C, that doesn’t get you off the hook. If you know you have canceled debt higher than $600, call the creditor. They must send a tax form to the IRS stating the amount of your canceled debt. They may have overlooked your copy, but that doesn’t cut your tax liability.

Canceled debt may make you feel lighter, but don’t forget your tax liability. One way or the other, you’ll pay some amount whether it’s to the creditor or to the IRS. Ignoring your tax liability could cause other issues, so keep careful track of any debt creditors cancel.