When you get a 1099-C, you are getting credited with income for a debt that was cancelled. First, we will go through the situations when this does not apply, then if you are still stuck with income from a debt cancellation, we will see how you can get out of it:
Cancellation of Debts that Are Not Income
The following types of common debt cancellations are not taxable:
1. When paying the liability would give you a tax deduction
2. Bequests and gifts.
3. Price reduced after purchase. If the seller reduces debt owed for property purchased, the reduction is generally treated as a purchase price adjustment that reduces basis and not a cancellation of the underlying debt.
4. Student loans where the debt is cancelled for doing public service. For example, you go to medical school and become a doctor in public service and your student loan debt is cancelled.
5. Debt that is qualified farm debt owed to a qualified person.
6. Debt that is qualified real property business debt.
7. You are the victim of certain disasters in the Midwest and you fall under Publication 4492-B.
8. Everything else is mostly taxable unless you can prove insolvency, covered in the last section of this article.
Cancellation of Debt That Might Be Income
Cancellations of debt on your principal residence, may or may not be income. Use this IRS tool to figure out if cancelled debt on your personal residence is taxable.
Getting Rid of All Other Cancelled Debt
By proving insolvency at the time of debt cancellation, you can get out of receiving the cancelled debt as income. Insolvency means being broke at that time with no way to pay the debt anyway. Under this scenario, debt that normally would be taxable can be deemed untaxable.
To see if you qualify, the best way is to fill out the IRS Cancellation of Debt Worksheet. Then to get the debt cancellation not treated as income, you need to fill out IRS Form 982 with your tax return. Given that you qualify, magically, the cancelled debt will now not count as income against you.
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