Individuals who encounter financial difficulty due to a job loss, high medical bills or other life challenge sometimes manage to negotiate a settlement of their credit card debt, resulting in a reduced repayment amount or an outright “forgiveness” of the debt. Imagine their surprise when they receive a Form 1099-C from the credit card issuer showing the amount of the reduction or forgiveness as income reported to the IRS.
Credit Card Loan Basics
When a credit card issuer extends a loan to a borrower, the loan agreement requires the borrower to repay the loan. The credit card issuer provides the borrower with funds up to a stated credit limit via a direct cash advance or goods charged to the credit card. The balance is expected to be paid in full, and any ongoing balance is not considered income.
Debt Cancellation - Loan Becomes Income
If the borrower defaults and the credit card company decides that the borrower cannot repay the full amount owed, the credit card company may nullify the loan agreement and cancel the debt. The nullification of the loan agreement changes the amount outstanding from loan balance to income.
Debt Forgiveness Example
Credit card debt cancellation occurs when the credit card issuer completely “forgives” a portion or the entire amount owed by a credit card holder because the debt is deemed wholly or partially uncollectible. For example, a credit card holder owing $10,000 may negotiate a settlement and agree to pay 60 percent -- $6,000 -- of the amount outstanding. Since the owner only repays $6,000, and the 40 percent or $4,000 "forgiven" amount exceeds $600, the IRS requires that the financial institution report that $4,000 as taxable income.
"Other Income" Reported on 1099-C
A borrower who receives a Form 1099-C for debt cancellation must report the canceled amount on his Form 1040 as “other income.” There are a few instances when a borrower does not have to claim the debt cancellation even though he received Form 1099-C from the lender. If, for example, the person was considered insolvent at the time of the debt cancellation, the amount forgiven does not have to be claimed as income. Any borrower who receives a 1099-C should double check the amount indicated for accuracy. Some banks tack on exorbitant late fees and interest that far exceed the borrowed amount. If the amount seems incorrect, contact the card issuer to request a corrected form.
