Why You Might Owe Taxes On Canceled Credit Card Debt

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If you had credit card debt canceled or forgiven in the last several years, don’t be surprised if the IRS comes knocking.

This year an increasing number of taxpayers are receiving 1099-C tax forms in the mail, and they’re quickly discovering that debt they thought was long gone can still be considered “income” by the federal government, and therefore subject to income taxes.

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The Internal Revenue Service estimates that it will send 6.4 million so-called 1099-Cs to taxpayers this year, which is up from 3.9 million in 2010. While many of those forms deal with debt that was discharged over the last few years – an estimated $75 billion in credit card balances was written off in 2009 and 2010 – canceled debt from 20 years ago is also reappearing in some cases.

According to the USA Today, the IRS even sent a 1099-C to an Austin, Texas, woman for canceled debt from a personal bankruptcy that was more than 20 years old. Because it was so long ago, she doesn’t have the paperwork to prove the debt was written off and is unable to file her taxes until the situation is resolved.

However, if you receive a 1099-C for discharged debt, you may still be exempt from paying taxes on it if you can prove that you were insolvent at the time you settled the debt. Most low-income families actually meet this criteria and don’t know that they can take the exemption. To do so, you have to prove that your liabilities exceeded your assets at the time of canceling your debt.

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Complicating the situation for those getting 1099-Cs is the fact that the IRS sometimes sends erroneous or duplicate forms to taxpayers. According to a taxpayer advocate quoted in USA Today, the U.S. Treasury “encourages financial institutions to issue 1099-Cs for debts if they haven’t tried to collect them in at least 36 months, even if the debts haven’t been forgiven.”

So if you receive a 1099-C, make sure to determine whether you’re exempt from paying those taxes. And remember to always hang on to your financial records. You never know when the IRS will ask to see documents from two decades ago.

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