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Forgiven Debt and Taxes

Being in debt is not pleasant, but when a debt is forgiven, it can be a huge weight off your shoulders. However, you need to consider taxes even when your debt is forgiven. That is because the IRS considers forgiven debt as income, and therefore, charges taxes on it. Taxes charged on forgiven debt are the same as any ordinary income.

irs tax debt

Usually, if your debt is forgiven, cancelled or discharged, you receive Form 1099-C, Cancellation of Debt. A copy of this form is available on the IRS website. If you receive Form 1099-C, but the creditor is still asking you to pay the debt, then you should clarify it with the creditor and pay taxes only if the debt is truly forgiven.

You must report the cancelled debt to the IRS on your tax return. You need to calculate the amount of taxes and report it on Form 1040. You are required to report the cancelled debt to the IRS on Form 1040 even if you did not receive Form 1099-C.

Exceptions

There are certain kinds of debts that qualify for an exception. These are:

  • Certain qualified student loans
  • Qualified purchase price reduction given by the seller
  • Pay-for-performance success payments that reduce the principal balance of home mortgage under Home Affordable Modification Program.

If any of these requirements are met, then the cancelled debt is not included in the gross income.

According to the IRS, other cases in which a cancelled debt qualifies for an exclusion from gross income and are not taxable are:

  1. 1. Debt canceled in a Title 11 bankruptcy case
  2. 2. Debt canceled during insolvency
  3. 3. Cancellation of qualified farm indebtedness
  4. 4. Cancellation of qualified real property business indebtedness
  5. 5. Cancellation of qualified principal residence indebtedness

If you do not qualify for exclusion, then you are required to pay taxes on the total amount of forgiven debt.

Unpaid Taxes

If you did not pay taxes on a cancelled debt, you may pay your back taxes in installments by filing an IRS installment agreement request. If the total amount you owe in back taxes is less than $50,000, then you may use an IRS online payment agreement.