When you owe money and do not pay the full amount of the debt the lender is required to file a 1099 form with the IRS showing that you had phantom income in the amount the creditor forgave. This is referred to as ‘forgiveness of debt’.
Exceptions to forgiveness of debt:
Certain instances of “forgiveness of debt” cannot be taxed – typically bankruptcy is one of those exceptions. These exceptions are listed on IRS form 982, which you must fill out and file with your tax returns. Make sure to read and follow the directions when filling out the form.
Negotiating a settlement of debt vs bankruptcy
Warning – sharks ahead!!
Negotiating a settlement of a debt will lead to tax obligations. Many of my clients tried to settle their own debts (either by hiring a company or doing it on their own), unfortunately no one warned them about the tax problems. These tax issues cannot be discharged in bankruptcy; at least for several years. Had my client filed bankruptcy to discharge the debt then, in most consumer cases, there are no tax consequences.
I filed bankruptcy then received 1099 Income Statement from a creditor.
When you receive a 1099 form after filing for bankruptcy then file the 982 form (discussed above). Mark the box that you filed bankruptcy and file the form with your tax returns. Keep a copy for your records.
Note – if the creditor forgave the debt prior to you filing for bankruptcy protection you may be faced with tax issues. But there might be another exception that protects you – check the ‘insolvency’ description on the 982 form to see if you qualify for that exception.
MUSINGS FROM DIANE:
Taxes, like bankruptcy, are far too complicated to do without competent guidance. This is similar to jumping off a cliff and then deciding to check below for rocks or sharks. Ask for experienced help before jumping or it will be too late to avoid the nightmare waiting for you.
333 words|1.8 min read|Categories: Bankruptcy, Taxes|By Diane Drain|Published On: February 17th, 2019|Last Updated: May 29th, 2022|
Diane is a well respected Arizona bankruptcy and foreclosure attorney. As a retired law professor, she believes in offering everyone, not just her clients, advice about bankruptcy and Arizona foreclosure laws. Diane is also a mentor to hundreds of Arizona attorneys.
*Important Note from Diane: Everything on this web site is offered for educational purposes only and not intended to provide legal advice, nor create an attorney client relationship between you, me, or the author of any article. Information in this web site should not be used as a substitute for competent legal advice from an attorney familiar with your personal circumstances and licensed to practice law in your state. Make sure to check out their reviews.*
When a debtor is in Chapter 13 bankruptcy, it is not unusual that their monthly payments are made through a plan rather than directly to the mortgage lender. At the end of the year, the mortgage lender is likely to send Form 1098 (mortgage interest paid through the year) to the trustee, not the homeowner.
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