Debtors exiting New York bankruptcy often receive IRS Form 1099-C, which creditors send to debtors and the IRS to inform both that it has canceled debts owed to them by the debtors. You can find the 2016 version here (pdf). Creditors are obligated to send these when they have canceled debts exceeding $600. Debtors, then, are expected to pay taxes on the canceled amount as though they actually received it as income.
Most debtors encounter Form 1099-C after they receive a bankruptcy discharge, so they are anxious to explain to the IRS that the canceled sum is not to be treated as income, which makes sense. Otherwise, bankruptcy wouldn’t have much of a purpose. Additionally, people who have sold their homes at loss, usually a short sale, will also receive one of these forms. Occasionally, lenders will cancel mortgage debt owed them by debtors who have offered their homes in lieu of foreclosure. There are many similar situations debtors can expect to receive Form 1099-C.
Often, debtors must pay the tax on the canceled debts. For instance, after 20 or 25 years, the federal government will forgive student loans owed by debtors on income-sensitive repayment plans. The forgiveness here is not tax free, but it is for a separate repayment program, the 10-year Public Service Loan Forgiveness plan, which applies to debtors who work for either the government or nonprofit businesses.
Just because a debtor receives a Form 1099-C does not mean the canceled amount must be paid, and unfortunately, the form itself does not specify what form debtors are supposed to complete to ensure negate the tax responsibility. The answer is usually Form 982 (pdf).
Part I of Form 982 essentially lists the situations in which debtors can be released from paying taxes on the canceled debt.
(1) Bankruptcy discharge
(2) Insolvency, as in having a negative net worth (I’ve discussed elsewhere how IRS insolvency is not like bankruptcy.)
(3) Discharge of “qualified farm indebtedness” (Farmers here are debtors who for the previous three years have received 50 percent or more of their gross receipts from the business of farming.)
(4) Discharge of “real property business indebtedness,” which mainly applies to the reacquisition of certain business debts occurring in 2009 or 2010 as part of the American Recovery and Reinvestment Act (2015 will probably be the last year this section applies)
(5) Discharge of “qualified principal residence indebtedness,” which is up to $2 million in mortgage debt, usually in the case of foreclosure or short sale, that occurred between 2007 and 2014 (This option will be unavailable to the vast majority of debtors this year.)
Bankruptcy debtors who receive Form 1099-C from a creditor will need to fill out Form 982 and read the directions carefully because most of the categories of forgivable debts are exclusive of the others. Debtors who have gone through foreclosure, short-sale, or other process of selling a home—and received loan forgiveness as a result, should consider discussing the tax debt with a New York bankruptcy lawyer if they do not wish to take the insolvency exception in Form 982.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.