Insolvency and Cancellation of Debt

Generally, if you are forgiven or discharged from debt in which you were personally liable, you are required to include the cancelled amount into income in the year in which it was cancelled. The company that is forgiving the debt will issue you a 1099-C showing this amount.

Keep in mind, if you default on a credit card, this process could take a couple of years before the company releases you of the debt. The correct thing to do upon receiving the 1099-C is amend the tax return for that year and pay the amount of taxes due.

There is an exception to the rule. If you were insolvent (your liabilities were more that your assets), you may be able to exclude this additional income on your federal tax return. Upon receiving the 1099-C, if you discover that you were indeed insolvent, you should still file the amended tax return and attach Form 982.

Keep in mind that state laws are typically not the same. They do not exclude this income regardless of your situation. The “income” will be added back to you state tax return and you will owe the taxes.

If you have questions, please let us know.