If you’re anything like me, your stomach drops when you receive any form of communication from the IRS.
That’s because if they’re sending you something in the mail, it's most often because you owe some clams to Uncle Sam. Inevitably, the government finds ways in which to squeeze revenues from as many angles as possible, especially with today’s trimmed public budgets and high government debt. In fact, credit card holders have often been the recipients of such attempts at increasing the public coffers.
For those who have not reported charged-off credit card debt to the IRS, you may have received such a nasty-gram from your friendly tax auditor. In such instances, they generally are requesting a submittal of Form 1099-C. And in this case, your Spidey-sense was right, the government wants more of your money.
What is Form 1099-C?
Like a standard Form 1099, Form 1099-C is a form for other earned income. Only in this case, it represents income earned from the cancellation of debts (hence the “C” in 1099-C). That’s right, the government considers your charged-off debts as earned, increasing your taxable income by the amount charged-off. In addition, you will find it interesting to note that the credit card company was able to write-off your credit card charge-off to bad debt expense, thus reducing their taxable income. It may not sound fair, but ultimately, you were responsible for the credit you took on and you are bearing the cost of wiping it off your personal books in the form of increased taxes.
How to Avoid Paying More Taxes
If you can prove insolvency to the IRS, you should be able to walk away from having to report more earned income through Form 1099-C. Proving insolvency is somewhat of an involved process, but may be worth it if you are unable to pay the tax increase your 1099-C requires. To prove insolvency and cancel any taxability from Form 1099-C, you will need to prove your assets outweigh your liabilities. That is, if you have more debts than assets, you will generally be judged as insolvent. To fully prove insolvency to the IRS, you will need to complete IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. If you read this blog, you hopefully know by now that Creditnet espouses keeping zero balances on all your credit cards. However, if you find yourself in a financial bind and end up dealing with charged-off credit card debt at some point in your life, be sure you know the rules and prepare yourself accordingly. Trust me, the last thing you ever want to receive is a letter from the IRS that makes your knees weak and your palms sweat.