Debt may not be canceled entirely with a 1099-C

This post originally appeared April 6, 2017 on as “‘Should I pay old card balance on a 1099-C I just received?

By Barry Paperno

Dear Speaking of Credit,
I had a credit card bill go to a charge-off and then to collections about five years ago. It never has been paid. I only just recently received a 1099-C form for this debt. And, although I can now pay most of it back, I’m wondering if I should. Any advice? – Chris

Dear Chris,
On the one hand, you owe a debt that you are obliged to pay. On the other, thanks to the passage of time and that 1099-C (Cancellation of Debt) form, your situation may provide a rare exception. As you’ll see, the impact of this 1099-C on your finances is likely to boil down to whether you could or couldn’t afford to pay the debt at the time it was effectively canceled.

What is a 1099-C (Cancellation of Debt) form?
When a debt is forgiven, settled, canceled or otherwise goes unpaid, the IRS considers that money to be taxable income for the consumer. When that debt amounts to $600 or more, the creditor is required to notify the debtor and the IRS of the debt cancellation via a 1099-C (Cancellation of debt) form.

Once the 1099-C has been sent by a creditor, the consumer has the responsibility to either report the debt on that year’s tax return or claim one of the 1099-C exemptions or exclusions available in this case, such as for “insolvency,” which is a possible option for you.

Now that you can, should you pay the debt?
You might be better served by simply letting that 5-year-old unpaid credit card balance continue to quietly fade into the sunset. The fact that you have received a 1099-C for such an old debt means you’ll want to consider at least some of the following reasons why:

  • Once the 1099-C has been issued on an old debt, it’s unlikely that the creditor will pursue you any further.
  • While varying by state, after five years, the statute of limitations allowing your creditor to sue for payment has either already expired or is probably close to expiring.
  • If you pay any less than the full amount now before the statute of limitations runs out, that action alone could essentially reset the statute of limitations’ clock and allow the creditor more time in which to sue you for the debt.
  • In less than two years from now (seven years total), whether paid or not, the collection and original credit card trade line will fall off your credit reports and no longer affect your credit scores.
  • Using the most popular – among lenders – FICO credit scoring models, paying a bad debt like this won’t add any points to your credit scores.

Exemptions and exclusions
Once receiving that 1099-C, there is one straight-ahead solution – reporting the debt and paying the tax. If you’re only looking for convenience, it’s easy enough to simply add the amount from Box 2 of the 1099-C to the “Other income” portion of your 1040 tax return, and pay any additional tax brought on by this added “income.” And this just may be the only avenue available to you if you cannot qualify for an exemption or exclusion.

If you were unable to afford the credit card bills during the time leading up to the cancellation of this debt, you might want to demonstrate that you were insolvent. You can do this by filing a Form 982 with your tax return. This could ensure that you won’t pay tax on at least a portion of the discharged debt. Doing so, however, could require a couple of labor-intensive tasks on your part – neither one particularly fun nor easy, but potentially worthwhile:

  • Many years have passed since you stopped paying the debt, so you may want to question whether the date (“Date of identifiable event”) on the 1099-C is accurate. If not, the burden will be on you to determine the correct date coinciding with the debt cancellation. Then you will need to contact the creditor and request they issue a corrected 1099-C. If they won’t comply, an adjustment to the tax return, or following the IRS dispute process (publication 4681), can fix that debt cancellation date.
  • Once an accurate date for the “event” has been established, list your total assets and liabilities as of this date. If your total assets equal the higher amount, you were solvent, and will have to add all of the reported debt from the 1099-C on your tax return. But if the total liabilities (debts) amounted to more than all of your assets at that time, you were insolvent, and therefore can reduce the reported debt by the amount your total debts exceeded assets.

Lastly, if you plan to file for the insolvency exemption, it’s a good idea to use a professional tax preparer with 1099-C experience, as some expert interpretation of the IRS rules may be required. The money saved and headaches avoided will be well worth it. Good luck!

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