Debt cancellation in Box 2 of Form 1099-C automatically becomes Taxable Income on Line 21 of Form 1040. However, you can file Form 982, and you may not have to pay taxes. This form became popular for us during the recession. It eliminated the otherwise taxable amount for cancellation of debt. Unfortunately, we still see lots of cancelled debt in 2016. That’s based on proactive calls from taxpayers expecting a 2015 Form 1099-C. Also considered are blogs from the CPA and financial fields and 2015 cancelled debt tax preparations.
Insolvency is when the amount of your debt is greater than the amount of your assets. Assets are things such as cash in the bank, or the value of property you own.
Example: you owe $15,000 on a credit card and $100,000 on a mortgage, for a total of $115,000 of debt. Your home is worth $105,000. Your car is worth $5,000, and you have $1,000 of cash in the bank This is a total of $111,000 of assets. Therefor, you are insolvent by $4,000.
Cancelled debt springs from a number of factors, including financial distress. So the IRS making cancelled debt taxable income seems unfair. This is especially alarming since it feels like you’re being taxed on money you never had. The IRS has multiple exceptions and exclusions that may allow. Thus, you could avoid being taxed on some, or all, of the cancelled debt listed in Box 2 of Form 1099-C. Insolvency is one exclusion, reported on Form 982.
The discharge of qualified principal residence indebtedness is available for 2016. Most folks don’t think Congress will extend it into the 2017 tax season (for 2016 tax preparation). Note that sometimes your accountant or tax preparer can help you establish an earlier date. However,this is only for your primary residence Form 1099-C. It also depends on the documentation you have from the lender. You are not likely to receive a Form 1099-C from a foreclosing lender on a recourse obligation. Because they want to hold out the possibility of recovering a deficiency for as long as they can. This of course is assuming that the anti-deficiency laws allow it.
There are only three ways a debt is cancelled: Payment by the obligor, voluntary cancellation by the lender or by operation of law. So since only part of the debt is paid by the foreclosure, and since you’ve only received a 1099-A, without that 1099-C, the claim stays alive until it dies by some other means.
Prudent tax pros generally counsel that it is wise to provide some sort of estimated liability if the property has been lost to foreclosure, and you still haven’t received her 1099-C. We, at Business & Financial Solutions, tend to disagree with that somewhat, because there is no COD tax until the debt is actually cancelled, and the debt isn’t cancelled until the lender or the law says it is. Estimating the liability based on an assumption that recourse debt will be cancelled eventually may create a need to amend the return later if the lender comes after you. Of course, if the debt is unambiguously non-recourse, meaning that no deficiency is possible, then it makes sense to go the estimate route because the debt is now cancelled by operation of law.
Some states don’t honor the federal qualified principal residence indebtedness exclusion of Form 982. So you may have change the way you file the State return to get some exclusion on the State level. Business & Financial Solutions can help you with that.
You may have to pay up to 20-35% of the amount of Box 2 of Form 1099-C, Cancellation of Debt, depending on your marginal tax bracket and what state you live in.
Contact Business & Financial Solutions to assist with these complications with your taxes. We have offices located in Rockville, MD, Frederick and Vienna, VA.
Cancellation of Debt
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