Form 1099-C – Cancellation of Debt / Form 982 – Reduction of Tax Attributes

What Is Cancellation of Debt?

“If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the canceled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C.

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.”

Home Foreclosure and Debt Cancellation. (n.d.). Retrieved December 15, 2014,
from http://www.irs.gov/uac/Home-Foreclosure-and-Debt-Cancellation

In general, the cancellation of debt results in taxable income. Certain exceptions to the taxable income rule apply, such as when the taxpayer is in bankruptcy, the taxpayer is insolvent, or the cancellation of debt is qualified principal residence indebtedness. If none of the exceptions apply, the cancellation of debt income is included in income in the year the debt is canceled.

You must report any taxable canceled debt as ordinary income. The various forms to be used for reporting taxable income follows:

Form 1040 or Form 1040NR, if the debt is a nonbusiness debt;

Schedule C (Form 1040), (or Schedule C-EZ (Form 1040)), if the debt is related to a nonfarm sole proprietorship;

Schedule E (Form 1040), if the debt is related to nonfarm rental of real property;

Form 4835, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or

Schedule F (Form 1040), if the debt is farm debt and you are a farmer.

Some of the most common situations when cancellation of debt income is not taxable involve the following:

Gifts and bequests.

The payment of the liability would have given rise to a deduction.

Student loans where certain debts are canceled in return for public service.

Price reduced after purchase. If the seller reduces debt owed for property purchased, the reduction is generally treated as a purchase price adjustment that reduces basis.

The cancellation takes place when the taxpayer is insolvent, to the extent the taxpayer is insolvent.

The debt is qualified farm debt owed to a qualified person.

The debt is qualified real property business debt.

The discharge of certain indebtedness of a qualified individual because of the Midwestern disasters. See Publication 4492-B.

To enter Form 1099-C in Keystone Tax Solutions from the Main Menu of the Tax Return (Form 1040) select:

Income Menu

Other Income (W-2G, 2555)

Cancellation of Debt (1099-C)

Form 1099-C Cancellation of Debt

Form 982 – Reduction of Tax Attributes

When an individual has a debt that has been discharged, the amount that was discharged is generally treated as taxable income to the individual. Under certain circumstances, this amount can be excluded from income, and therefore not taxed. In order to report the exclusion, the taxpayer must file Form 982 with their tax return.

You can also use the Interactive Tax Assistant available on the IRS website to determine if cancelled debt is taxable. The ITA takes you through a series of questions and provides you with responses to tax law questions.

To enter Form 982 in Keystone Tax Solutions from the Main Menu of the Tax Return (Form 1040) select:

Income Menu

Other Income (W-2G, 2555)

Cancellation of Debt (1099-C)

Form 982-Reduction of Tax Attributes

NOTE: This is a guide on entering cancellation of debt into the Keystone Tax Solutions program. This is not intended as tax advice. For additional information refer to the Additional Links below.

Additional links:

Publication 544, Sales and Dispositions of Other Assets

Publication 908, Bankruptcy Tax Guide

Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments

Updated on July 10, 2018