A 1099C form just came in the mail, is this cancellation of debt (COD) income? And if so, what are the tax ramifications?
19 February 2015
This is the time of year that people are taking a look at the tax documents they have received and one of these can be a 1099C from. This is an entity claiming that it forgave/cancelled debt owed by you to it. The cancellation of this debt is generally taxable. (But wait for the good news below.) It is called cancellation of debt income.
Receiving a 1099C form and being informed for the first time that COD income can be taxable can startle and confuse many people. The idea that cancelled debt can be taxable is not known by most Americans. The author can recall learning about COD income in tax class in law school and being surprised by the idea. But, it is a reality. Let’s take a brief look at what can be done about it.
The bad news first. In 2007 Congress passed The Mortgage Forgiveness Debt Relief Act. Basically, it was a law that declared COD income from the forgiveness of mortgage debt to not be taxable, for many at least. This gave most Americans the guarantee that if their bank forgave the deficiency after a foreclosure, forgave mortgage debt as the result of a deed in lieu deal, or for some other reason mortgage debt was forgiven, it was not taxable. However, this expired in 2014, so if you are receiving a 1099C this year (2015) you will not have the benefit of this Act.
The good news is that for most Americans the COD income will still not be taxable. This is because most Americans are balance sheet insolvent. What does that mean? It means that most Americans owe more than they own. It means if they produced an individual balance sheet with all of their debts on one side and all of their assets on another, the debts would outweigh the assets.
You see, pursuant to tax law, COD income is only taxable to the extent of someone’s solvency. The way this author understands it, and said in a different way, COD income is not taxable to the extent someone’s debt outweighs their assets. And if you are like most Americans, your debts will outweigh your assets more than the amount of the COD income you just received. This is one time that you are glad you are not rich like one of the sharks on Shark Tank.
Keep in mind, this blog just touches the surface of the subject and you should not rely on it to make decisions. A better explanation comes from the IRS itself here https://www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation. Even this IRS information is not enough to equip an individual to prepare their own tax return involving COD income. If you have received a 1099C form, this author recommends to hire an excellent, competent tax professional (this is not something to go to H & R Block about) and be prepared to pay more than you usually do to have your taxes prepared.
In the event that you have financial and legal matters that you need legal advice for, feel free to contact the author to consider an engagement.