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GOT A 1099-C?

The tax laws of the United States provide that if a debt is canceled or forgiven, you can be taxed on the amount of the “forgiven debt.”  Collection agencies and credit card companies eagerly comply with the Internal Revenue Code by sending out an IRS Form 1099-C in January of the following year.  The 1099-C reports the amount of a forgiven debt as taxable income.

It is common when making a settlement with a credit card company for the creditor to “forgive” all or part of a consumer’s credit card balance.  A representative of a creditor may prefer to cancel a credit card balance than make a monetary payment to a consumer.  The consumer should take the tax consequences of a 1099-C into account when negotiating a settlement with a creditor.  Money paid as damages for emotional distress is considered to be compensation for personal injuries and is not subject to tax.

Sometimes, the correct amount of the debt is disputed.  For example, if the creditor failed to provide the proper written disclosures required by the Truth in Lending Act (“TILA”) when the account was first opened, all interest assessed since the opening of the account may be considered void and all payments may be considered payments on the principal.  If the creditor is going to file a 1099-C, try to negotiate the amount that will be put into Box No. 2 and the amount that will be put into Box No. 3 on the Form 1099-C.  The amount of “taxable income” is the amount of principal being forgiven.  Forgiveness of interest, finance charges, services charges and fees is not principal and is not “taxable income” under Internal Revenue Code.  Also, look at IRS Form 982.

If the amount of principal being forgiven is large, be sure to consult your tax preparer, financial advisor or accountant.

A final note about taxes.  Monetary compensation for emotional distress is considered to be damages for personal injuries, which is not taxable.  A settlement, award or judgment for lost earnings is taxable.  Punitive damages are taxable.   Keep the settlement dialogue open during trial, during jury deliberations, during the time when a motion for a new trial is pending and during appeal.  During settlement negotiations you can structure and characterize the settlement in a way that maximizes the tax advantages and minimizes tax liability.  If you get a judgment, the tax consequences cannot be negotiated.