So, you’re a master negotiator. You’re skills are on par with the best hagglers at the flea market and you know you can pretty much negotiate like a boss. Knowing that, you decide that you are going to try and negotiate the amount of money owed to your bank. You go in for the kill and the bank wiped away your loan. Like magic the debt is gone! Celebrations are certainly in order but did you know the canceled debt may count as taxable income?
Need a little bit more of an explanation? Let’s talk this through. Suppose you had $10,000 in debt and with your ninja negotiating skills you were able to have the bank agree to wipe away $5,000 of that debt. Yay! Happy dances are in order because that’s half you don’t have to pay back. While you no longer owe the bank you may owe the IRS. That $5,000 you saved is now considered taxable income. Think of it as the bank giving you the money to pay the loan back instead of just wiping it away.
Now, suppose you don’t remember or not sure which forms you’ll need. The financial institution has its due diligence and will issue a 1099-C if the debt cancelled or forgiven is $600 or more. Please pay close attention to your year-end statements and summaries as your 1099-C may be included or not too far behind in the mail or inbox. Really… Don’t ignore this form. Bring it to my office so we can make sure to handle everything correctly. We are in the business of having everything taxes straight around here!
I know what you’re thinking. “I’m 8 years in on a 10 year student loan forgiveness program. I have to claim the amount forgiven as income?” Guess what? If you have a federal student loan, no you do not! No need to stress. Make sure you are eligible for student loan forgiveness with your student loan provider. If the student loan is with a private lender most likely the debt will not be forgiven and even if it is you will still have to claim the cancelled debt as taxable income. With everything there is an exception or exclusion. Student loans are one and actually, there are a few other exceptions as well.
The Mortgage Debt Relief Act of 2007 is a huge help to those who had their debt reduced through a restructured mortgage or if the loan was simply forgiven. This ACT was meant to help those who were personally victimized by the financial and housing crisis from 2007 to 2014. If this happened to you during in 2016 there is good news for you! The PATH Act extended this policy until the end of 2016. How awesome is that!?
Another exception to the rule is Title 11 bankruptcy. If you declared Title 11 bankruptcy the cancellation of debt is not counted as income. You’ve established in court and already paid plenty of money to go through the process of bankruptcy. The debt should not count and does not count. You’re covered and this is a great time to leverage any tax breaks you have to work on your financial fitness.
There are other exceptions and exclusions so you will definitely want to book an appointment to make sure your ducks are all in a row to file your 2016 taxes. Filing can be so much more than just a W-2 and I’d be more than happy to help you with your W-2, 1099-C, 1040, Schedule A, etc. I know. There’s too many numbers, letters and schedules! Take a deep breath because we got this.
Anyway, although it may feel like you are still paying for the debt if it is cancelled or forgiven think about it like this. Taxes possibly paid today as a result of canceled debt may save you a lot more money than if you had of paid the total balance of the debt plus interest and possibly fees. You’re still getting a great deal in the grand scheme of things so don’t get too caught up on this one. Like I said before… we got this!