It’s tax time and questions about foregiveness of debt income seem to abound.
Things to remember: lenders and debt collectors feel themselves bound to send out a 1099 whenever they handle a transaction that may implicate cancellation of debt. Receipt of a 1099 is not the final word on the topic, only notice that the transaction in question has been reported to the IRS.
The standard rule is that debt that is cancelled is treated as though you had received that much cash, and that pseudo-cash is treated as income. The exceptions to recognizing that transaction as income include 1) insolvency at the time, and 2) discharge of the debt in bankruptcy.
You have to file an IRS form to rebut the 1099. It’s form 982 and right at the top are the boxes to check to invoke the exceptions.
Remember, too, that there is special legislation dealing with cancellation of debt upon loss of a primary residence, excluding phantom income from qualifying transactions.
Here’s the IRS on the subject: http://www.irs.gov/taxtopics/tc431.html
[...] earlier post on cancelled debts, and the tax consequences of [...]