Income tax considerations for cancelled credit card debt

If your credit card debt has been canceled or forgiven, you likely (and understandably) think that you will no longer have to deal with it. Unfortunately, that may not be the case. Under federal income tax filing guidelines, credit card debt that been eliminated through cancellation or forgiveness is considered taxable income.

Specifically, taxpayers who receive a 1099-C form from a creditor must pay taxes on that cancelled debt, unless they can prove to the IRS that the debt was discharged through bankruptcy or that they were insolvent at the time of the cancellation.

One common issue with 1099-Cs is that they often contain errors or are in regard to debt that was cancelled years ago. Some taxpayers have reported receiving 1099-Cs for the same debt. And attempts to resolve the errors are often tedious and ultimately fruitless.

If you are in this situation, you are not alone. According to IRS projections, creditors will send 6.4 million 1099-C forms to taxpayers in 2012, a significant increase from the 3.9 million forms that were sent in 2010. In addition, it is estimated that the country’s six largest credit card companies wrote off more than $75 billion in uncollectible balances in 2009 and 2010, as debtors struggled with the aftermath of the economic recession.

Under a current tax exemption, homeowners are not required to pay taxes on cancelled mortgage debt for a principal residence if that debt was forgiven in a foreclosure, short sale or loan modification. However, that exemption is scheduled to expire at the end of 2012, and unless Congress takes action, residents of Georgia and other states in which foreclosure rates are high could find themselves in an even more precarious financial situation.

Source: USA Today, “Canceled credit card debts come back to haunt taxpayers,” Sandra Block, Mar. 4, 2012