Creditors like to issue 1099-c documents if they’ve worked out a settlement and decided to forgive the debt entirely. Creditors also issue 1099 forms when bankruptcy is filed and it discharges the obligation to pay the debt. These forms also show the IRS that the debt forgiven matches the amount written off in their own tax return.
Avoiding tax on forgiven debt
If the debt obligation is discharged in bankruptcy and the creditor issues a 1099 form, the law requires the bankruptcy filer to show the amount forgiven on the tax return. However, debt forgiven as a result of a bankruptcy discharge doesn’t cause “cancellation” of debt income and on IRS Form 982 the bankruptcy filer can make clear to the IRS that the forgiven debt isn’t taxable, by simply marking the box.
If the debt was forgiven outside of bankruptcy, then the amount of the debt that counts as income depends on how “insolvent” you were on the day before the forgiveness took place. Form 982 is used again to show the IRS that the included debt forgiveness amount should be reduced as income based on the insolvency amount. Talk to your Accountant about this.
If the debt was forgiven outside of bankruptcy, then the amount of the debt that counts as income depends on how “insolvent” the person was on the day before the forgiveness took place. Form 982 is used again to show the IRS that the included debt forgiveness amount should be reduced as income based on the insolvency amount. Talk to your Accountant about this.
But what happens if the 1099-C is incorrectly issued
Sometimes a creditor will issue a 1099-C to someone who hasn’t actually filed for bankruptcy or settled the debt. This tends to happen to a joint debtor whose partner on the debt has negotiated a settlement or filed for bankruptcy. Usually, the partner is an ex-spouse but it can be a business partner or other family member.
Post-bankruptcy, the partner shouldn’t be receiving the 1099-c as the bankruptcy discharge doesn’t apply to the personal liability of that spouse, ex-spouse or other.
If this happens, the first step is to contact the creditor and ask them to correct the 1099 form. The creditor issues the form to the individual several weeks before it sends the form to the IRS. This provides enough time to make the contact and try to get the problem fixed.
If the form has already reached the IRS, a form 982 may need to be filed with the 1040 and an explanation attached containing the reason why the debt wasn’t actually forgiven, i.e. didn’t file for bankruptcy and no personal liability discharge occurred as a result.
Debt Settlement Versus Bankruptcy
For someone struggling with credit card debt, settling for less than the amount owed can be a real blessing until the 1099 form is received. If money is being saved for the purpose of settling a debt, forgiven debt as income should be taken into account before a settlement is reached. An advisor should be mapping out whether insolvency will be a way to avoid tax on the forgiven amount or not.
Bankruptcy avoids the issue entirely as debts discharged in bankruptcy aren’t treated as taxable income and the IRS won’t try to treat them this way as long as the 1040 form is accompanied by the 982 form and the correct box is checked.
It’s easy to file a tax filing extension with the IRS. A simple form is filled out, the amount you think you owe is included, and in theory… that amount and the form are sent into the IRS before the April 15th deadline.
This allows you to put off filing the return until much later in the year.
I often see two problems associated with filing the extension.
The first is that many people don’t have the amount owed available to send with the extension request.
The second is that many people already owe the IRS from previous years.
The first problem results in a penalty for failure to pay on time. The second does this and more.
If you already owe the IRS, the lack of withholding just adds to the debt. This can make it more difficult to convince the IRS to settle your debt or to place you into an IRS payment plan. There is also a penalty for failure pay what’s owed when due.
If you are a bankruptcy candidate, it can make your bankruptcy more complicated, especially if the case is a chapter 13 bankruptcy.
I suggest that you do your 2015 return as soon as you possibly can when 2016 rolls around. Use it to figure out, as close as possible, how much you should be withholding each paycheck or each quarter, and adjust your situation so that you can start paying it.
This works the other way as well. If you are getting a refund, you have provided the Government an interest free loan. You need to reduce the withholding so that your net monthly income is increased and you get zero refund or as close to zero as possible.
Divert the money you get each month to a retirement plan or pay down other debt with it.
A recent case out of the US Bankruptcy Court in the Southern District of Florida, Coyle v. U.S., has rejected the McCoy line of cases and relied on the beard test to determine whether tax debt based on returns filed after IRS assessment can be discharged. The taxpayer in question filed returns after the IRS created substitute returns and based it’s assessment on them.
The Court cited Pendergast v. Mass. Dept. of Revenue 510 B.R. 1 (B.A.P 1st Cir., 2014) and wrote that “if a return is filed late, discharge-ability depends on the taxpayer’s cooperation with the taxing authorities”. It rejected the McCoy reasoning and stated that it agreed “with the IRS and those courts that have rejected a narrow reading of the Hanging Paragraph under which the only late filed returns eligible for discharge pursuant to Sect. 523 (a)(1)(B)(ii) are returns filed under Sect. 6020(a)”
This is a small bit of good news for taxpayers with large tax debts who are contemplating bankruptcy and have filed the return(s) late. It isn’t good news for those who filed late and filed after the IRS assessed a debt based on an IRS Substitute Return.
If you live in the 9th Circuit, the IRS position mirrors this case and is currently how cases are being treated in Arizona. This could change.
Millions of Americans fail to file tax returns each year for various reasons. The most common reason we see is simply procrastination combined with a dash of fear. Every late tax return filer worries about what the consequences might be. Some think about it every day of their lives. If this sounds familiar, here are nine things you need to know.
1. Lost Refunds In order to receive a refund if you are owed one, the return must be filed within three years of the due date. Yes ¦they will keep it no matter how large it is, and yes it is often a very large windfall for the government.
2. Lost Earned Income Credit
The 3 year rule strikes again. Failure to file within that time period means that your “Earned Income Credit” will be lost as well.
3. Lost Social Security Benefits
If you are self employed, you have to file returns reporting self employment income within three years of the due date in order to receive social security credits toward retirement.
Income is reported to the IRS both from employers and from others. So, even if you are self employed, the IRS may have information about how much your clients paid you in a given year. At some point, the IRS will use that information to create a tax return for you. It won’t be correct, as it won’t contain correct deductions. It can be used to assess a debt and begin the collection process however. The assessment of the tax based on a substitute return can also create other serious problems related to future tax debt options like bankruptcy.
The IRS is starting to catch up to the computer age. As a result, it has ramped up it\’s pursuit of non-filers. It can charge non-filers with a crime. The willful failure to file is a misdemeanor and can result in a sentence of up to one year in prison for each tax year not filed.
7. Avoiding Prosecution
Most people with unfiled returns will avoid criminal prosecution for three reasons.
Numbers: It is difficult for the IRS to get to everyone right now. There are just too many non-filers and too few employees in relation.
The Voluntary Compliance Program: If the non-filer attempts to come forward before an IRS investigation or examination ensues, he or she will usually avoid prosecution related to the failure to file the returns.
IRS can’t prosecute after six years: The IRS is barred from prosecuting the failure to file a tax return if the return twas due to be filed more than 6 years ago.
8. The substitute return can be challenged
The substitute return mentioned above can be challenged via the audit reconsideration process. This means that even though the IRS has filed the return with incorrect numbers, it will consider and usually accept your correct return even if filed much later. Whether it makes sense to use this process to deal with the debt, depends on the individual circumstances of the case.
9. If the IRS files Substitute Returns First – You can probably forget using Bankruptcy later to discharge the debt.
In most Jurisdictions, the filing and assessment of a substitute return by the IRS before you file the correct return makes it difficult to treat the tax debt as dischargeable in bankruptcy. If you suspect that you may owe a large amount of income tax debt and want to preserve the ability to discharge it in bankruptcy later, your returns should be filed before the IRS gets a chance to do it for you.