Form 1099-C: Cancellation of Debt (2014) – A Complete Guide

What Form 1099-C Is For

Form 1099-C, Cancellation of Debt, is an information return that creditors send to you and the IRS when they cancel, forgive, or discharge $600 or more of debt that you owed. Think of it as a financial report card that says, "This person no longer owes us money." You receive this form because a bank, credit union, credit card company, federal government agency, or other qualified lender has essentially wiped away a debt—and the IRS considers that canceled amount as income you received, just as if someone handed you cash.

The form comes from "applicable financial entities," which include banks, credit unions, the Federal Deposit Insurance Corporation (FDIC), credit card companies, finance companies, and any organization whose main business involves lending money. Even federal agencies like the U.S. Department of Agriculture can issue this form.

When you get Form 1099-C, Box 2 shows the amount of debt canceled (including principal and sometimes interest, fees, or penalties), Box 1 shows the date of the "identifiable event" that triggered the cancellation, and Box 6 contains a code letter (A through I) explaining why the debt was canceled—ranging from bankruptcy (Code A) to a simple agreement between you and the creditor (Code F).

When You’d Use Form 1099-C (Including Late or Amended Situations)

You typically receive Form 1099-C by January 31 of the year following the calendar year in which your debt was canceled. For 2014, creditors were required to file this form for any debt of $600 or more that was canceled during that year based on an "identifiable event."

When you must report it

You should report the canceled debt on your 2014 tax return (Form 1040, line 21 for nonbusiness debt, or Schedule C for business-related debt) unless you qualify for an exception or exclusion. Even if you don't receive a Form 1099-C, you're still required to report canceled debt as income if it doesn't qualify for an exclusion.

Late filing situations

If you discover later that you should have reported canceled debt on your 2014 return but didn't, you need to file an amended return using Form 1040X. This commonly happens when people don't realize the canceled debt is taxable, or when they receive a Form 1099-C late.

Amended return scenarios

You might also need to amend if you originally reported the full amount as income but later realize you qualified for an exclusion (such as insolvency or bankruptcy), or if the creditor issues a corrected Form 1099-C with a different amount.

Key Rules or Details for 2014

Several important rules governed Form 1099-C in 2014:

Reporting threshold

Creditors must file Form 1099-C when they cancel $600 or more of debt and an "identifiable event" occurs. This could be a bankruptcy discharge, a court-ordered cancellation, expiration of the statute of limitations, foreclosure that extinguishes the debt, an agreement to settle for less, or the creditor's decision to stop collection efforts.

The 36-month rule (Code H)

For financial institutions and credit unions, if they haven't received payment on a debt for 36 months ending on December 31, 2014, they must file Form 1099-C—even if they haven't actually forgiven the debt. This often confuses people who suddenly receive a 1099-C for an old debt they thought was simply forgotten.

Joint debts

If you and another person (like a spouse) were jointly liable for a debt of $10,000 or more incurred after 1994, each of you may receive a Form 1099-C showing the entire canceled amount. However, you don't necessarily each owe tax on the full amount—it depends on who received the loan proceeds and other factors.

Recourse vs. nonrecourse debt

For recourse debt (where you're personally liable), canceled amounts are ordinary income. For nonrecourse debt (secured only by property, like some mortgages), if the lender forecloses and cancels debt, the entire debt amount is treated as part of the sale proceeds rather than cancellation of debt income.

Qualified principal residence indebtedness exclusion

For 2014, you could exclude up to $2 million of forgiven mortgage debt on your main home if the debt was used to buy, build, or substantially improve that home and was secured by it. This was particularly important during the housing crisis years.

Step-by-Step (High Level)

Step 1: Receive and review your Form 1099-C

Check Box 2 for the canceled amount, Box 1 for the date, Box 6 for the reason code, and Box 3 for any interest included in the canceled amount.

Step 2: Determine if an exception applies

Some canceled debts aren't considered income at all. These include: debts canceled as gifts or inheritances; certain student loans canceled because you worked in specific professions; amounts that would have been deductible if you'd paid them (for cash-method taxpayers); and price reductions from the seller after purchase.

Step 3: Check if an exclusion applies

Even if no exception applies, you might exclude the canceled debt from income if: the debt was canceled in bankruptcy (Code A); you were insolvent immediately before cancellation (your debts exceeded your assets); the debt was qualified farm indebtedness; the debt was qualified real property business indebtedness; or the debt was qualified principal residence indebtedness.

Step 4: Calculate your exclusion amount

If you qualify for the insolvency exclusion, complete the Insolvency Worksheet in IRS Publication 4681. Add up all your liabilities (debts) and subtract the fair market value of all your assets immediately before the cancellation. If the result is positive, you were insolvent to that extent.

Step 5: Complete Form 982

If you're excluding any or all of the canceled debt from income, you must file Form 982, Reduction of Tax Attributes, with your tax return. Check the appropriate box (1a for bankruptcy, 1b for insolvency, 1c for qualified farm debt, 1d for qualified real property business debt, or 1e for qualified principal residence debt) and enter the amount you're excluding on line 2.

Step 6: Reduce your tax attributes

When you exclude canceled debt from income, you generally must reduce certain tax benefits (called "tax attributes") in Part II of Form 982. These include net operating losses, capital loss carryovers, tax credits, and the basis of your property.

Step 7: Report any remaining taxable amount

If the canceled debt exceeds your exclusion amount, report the remaining balance as ordinary income on your tax return—line 21 of Form 1040 for nonbusiness debt, or the appropriate business schedule for business debt.

Common Mistakes and How to Avoid Them

Mistake #1: Ignoring the form because you didn't receive cash

Many people think, "I didn't get any money, so why do I owe taxes?" The IRS treats canceled debt as income because you received a benefit when you originally borrowed the money and spent it. To avoid this mistake, understand that debt forgiveness creates taxable income unless an exception or exclusion applies.

Mistake #2: Reporting the full amount when you were insolvent

Thousands of taxpayers unnecessarily pay tax on canceled debt because they don't realize they can exclude amounts while insolvent. Use the Insolvency Worksheet in Publication 4681 to calculate whether your debts exceeded your assets. Include all assets (even retirement accounts and exempt property) and all liabilities.

Mistake #3: Confusing the date on the form with the tax year

Form 1099-C shows the date of the identifiable event in Box 1, which determines which tax year to report it. A debt canceled on December 15, 2014, goes on your 2014 return—not your 2015 return when you receive the form in January.

Mistake #4: Failing to file Form 982 when claiming an exclusion

You cannot simply ignore Form 1099-C and not report it anywhere. If you're claiming an exclusion, you must attach Form 982 to your return. Without it, the IRS will likely send you a notice proposing additional tax.

Mistake #5: Not reducing tax attributes

When you exclude canceled debt under most exclusions (except the purchase price reduction), you must reduce tax attributes on Part II of Form 982. Failing to do so can cause problems in future years and may trigger an IRS audit.

Mistake #6: Treating old collection activity as actual cancellation

Sometimes creditors file Form 1099-C under the 36-month nonpayment rule (Code H) even though they haven't legally forgiven the debt. If facts and circumstances show the debt wasn't actually canceled (the creditor is still pursuing collection, or you later make payments), the debt isn't actually discharged, and you shouldn't report it as income.

Mistake #7: Overlooking the qualified principal residence exclusion

During 2014, the Mortgage Forgiveness Debt Relief Act was still in effect (it applied through December 31, 2014). Many homeowners with foreclosures or short sales could exclude up to $2 million of forgiven mortgage debt on their primary residence but failed to claim this valuable exclusion.

What Happens After You File

Immediate aftermath

Once you file your 2014 tax return with Form 1099-C properly reported (either as income or excluded via Form 982), the IRS processes your return and matches it against the Forms 1099-C that creditors filed. This matching process usually takes several months.

If everything matches

The IRS accepts your return, and you don't hear anything further about the canceled debt. However, if you claimed an exclusion and reduced tax attributes, those reductions carry forward and affect your future tax returns. For example, if you reduced the basis in your home by $20,000, you'll have a higher gain (or lower loss) when you eventually sell it.

If there's a discrepancy

The IRS may send you a CP2000 notice (Underreporter Inquiry) proposing that you didn't report income shown on Form 1099-C. You'll have the opportunity to respond, explain why you excluded the debt (such as insolvency), and provide supporting documentation. Common reasons for these notices include: failing to report the 1099-C at all; reporting it on the wrong line; or claiming an exclusion without filing Form 982.

Statute of limitations

Generally, the IRS has three years from the date you filed your return to assess additional tax. However, if you substantially underreported income (by 25% or more), the period extends to six years. For unreported canceled debt, this could apply.

State tax implications

While this guide focuses on federal taxes, remember that state tax treatment of canceled debt may differ. Some states don't conform to federal exclusions, meaning you might owe state tax even if the debt is federally excluded. Check your state's rules for 2014.

Future credit implications

From a credit perspective, canceled debt typically appears on your credit report as "settled" or "charged off," which can negatively impact your credit score for up to seven years. However, this is separate from the tax consequences.

Bankruptcy situations

If your debt was canceled in bankruptcy (Code A), you exclude it from income by checking box 1a on Form 982. The advantage of bankruptcy cancellation is that you don't have to reduce the basis of property you retain in bankruptcy, preserving more tax benefits than other exclusions.

FAQs

Q1: I received a Form 1099-C in 2015 for a debt from 2011. Which year do I report it?

Generally, you report canceled debt in the tax year shown in Box 1 (date of identifiable event). If your 2011 return is already filed, you may need to amend that return. However, if the creditor improperly issued the form late, consult a tax professional. The IRS has indicated that if you receive a 1099-C years after the actual cancellation, and the statute of limitations for that year is closed, you may be able to report it in the year received.

Q2: Can the creditor still collect on the debt after issuing Form 1099-C?

This is tricky. Some creditors issue Form 1099-C after 36 months of nonpayment (Code H) even though they haven't legally forgiven the debt and may still have the right to collect. However, most other identifiable events (like Code F, settlement by agreement) represent actual forgiveness where the creditor cannot later collect. Check your agreement with the creditor and consult state law about whether the debt is truly discharged.

Q3: My spouse and I filed separately, but we both received a 1099-C for the same joint debt. Do we each pay tax on the full amount?

No. While creditors may send each joint debtor a Form 1099-C showing the full amount, you should only report your share based on how you used the loan proceeds, what basis each of you had in property purchased with the loan, and how you allocated any deductions. If you both qualified for an insolvency exclusion, each of you calculates your own insolvency separately using your individual assets and liabilities plus your share of joint obligations.

Q4: I lost my home to foreclosure in 2014, and the lender sent me a Form 1099-C. Do I have to pay tax on that?

It depends on several factors. First, determine if the mortgage was recourse (you were personally liable) or nonrecourse (lender could only take the house). Second, check if you qualify for the qualified principal residence indebtedness exclusion—if the home was your main home and the loan was used to buy, build, or improve it, you can exclude up to $2 million of forgiven debt. Third, if you don't qualify for that exclusion, check if you were insolvent. Many people who lost homes during financial hardship were insolvent and could exclude the canceled debt on that basis.

Q5: What assets and debts do I count when calculating insolvency?

Count everything. Assets include: cash, bank accounts, investments, retirement accounts (401(k)s, IRAs), home equity, vehicle equity, personal property, and even tax refunds due. Liabilities include: mortgages (only the amount not exceeding the property's value for nonrecourse debt), credit card balances, student loans, car loans, personal loans, medical bills, taxes owed, and any other legal obligations. Use fair market values immediately before the debt cancellation.

Q6: I excluded canceled debt under the insolvency exclusion. What does "reducing tax attributes" mean?

Reducing tax attributes means decreasing certain tax benefits in a specific order. Think of it as the IRS saying, "We won't tax you now on this canceled debt, but you lose other tax breaks to make up for it." You reduce (in order): net operating losses, general business credits, minimum tax credits, capital loss carryovers, basis in property, passive activity loss and credit carryovers, and foreign tax credit carryovers. For most individuals, the biggest impact is reducing the basis in property (typically your home), which means you'll have more gain when you eventually sell it.

Q7: Can I exclude canceled credit card debt?

Yes, if you qualify for one of the exclusions. Credit card debt can be excluded if you were insolvent when the debt was canceled, or if it was discharged in bankruptcy. However, the qualified principal residence indebtedness exclusion doesn't apply to credit card debt (even if you used the card for home improvements) because it wasn't secured by your home. For credit card debt, insolvency is your most likely exclusion.

Sources

IRS Form 1099-C Instructions (2014)
IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (2014)
IRS Topic 431: Canceled Debt – Is it Taxable or Not?

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