There are many people who end up settling their credit card debt for much less than the original cost that they racked up. This allows those people to start over with a completely clean slate, no longer having to worry about the tons of credit card debt they owe to the credit card company. However, while credit card debt and other forms of debt can lead to forgiven debt when a settlement takes place, you can still end up owing some money to the IRS and having to deal with some tax implications from the IRS.
How Does Forgiven Debt and Taxes Work?
Let’s say that you have managed to rack up $50,000, all in credit card debt, within the span of several years. You may be able to negotiate that debt with the company that has distributed the credit card to you, offering them a smaller amount as a means of paying off the complete debt. Let’s say that instead of offering $50,000 to the credit card company, you offer $30,000, more than half of what you owe but not the complete amount. The credit card accompany may accept your offer as a means of collecting money that is owed to them. After collecting this amount, the rest of your debt, which is $20,000, will be forgiven. However, while you might think that you got lucky, not having to pay the full amount, the credit card company informs the IRS about the forgiven debt. The IRS will then classify the $20,000 as taxable income. So, during tax time, along with your regular W-2 forms and 1099’s you will also receive a 1099-C from the credit card company for the amount of debt that has been cancelled.
Filling Out Form 982
If you are unable to pay the debt that you will now owe the IRS, which is often referred to as being insolvent, you will have the option of using Form 982 ”Reduction of Tax Attributes Due to Discharge of Indebtedness” when filing your taxes. Form 982 allows you to avoid paying taxes on the forgiven debt that was reported on the 1099-C. To use the form you have to be insolvent the day before the debt was forgiven. You are deemed insolvent when your liabilities (credit card debt, mortgage, student loans, etc.) outweigh your current assets. If you are confused by the form when filing, you will simply need to fill out the amount of cancelled debt that you did owe to the credit card company but no longer owe. If you are, however, not insolvent, you will have to pay back the taxes on that money that you would have owed to the credit card company. This can definitely be frustrating for those who have recently gotten out of the credit card debt. However, the plus side about the entire situation is that if you do end up needing to pay the taxes back to the IRS because you are not insolvent, you will still be paying far less than the amount that you owed to the credit card company in the first place.