I received my first 1099 for tax year 2012 last week. And while the weather suggests “It’s beginning to look a lot like Christmas” it’s also a reminder that we’re only 3 months away from our mailboxes filling up with tax forms, including 1099s. And while 1099 is normally reserved for non-employee income, like contractor work, it has an evil stepsister that many of you will or have already received…IRS Form 1099-C.
A 1099-C is sent by your credit card issuer. It represents debt that they have forgiven, or a “cancelation of debt.” It means you cut a deal with your credit card issuer and they accepted less than you really owed and considered the balance to be settled in full. What, did you really think you were out of the woods when you settled that debt? That debt settlement company you hired didn’t tell you that settling debt would create a taxable event for you?
A 1099-C looks like this…
According to the IRS, “Generally, if a taxpayer receives Form 1099-C for canceled credit card debt and was solvent immediately before the debt was canceled, all the canceled debt will be included on Form 1040, line 21, Other Income. No additional supporting forms or schedules are needed to report canceled credit card debt.” I’m not a tax expert but that sounds like you’ll be paying taxes on the forgiven amount since it’s considered income.
Now, as to credit reporting…how should the settled account be reported to the credit bureaus? First off, settled debts are not paid in full…they’re settled in full…big difference. That big difference is often overshadowed by what’s similar between the two, which is there is nothing due to the creditor any longer. As such the account should be reported to the credit bureaus as having a $0 balance. According to Maxine Sweet, Experian’s Vice President of Public Education, “If the lender agrees to settle the debt for a lesser amount, the account should be reported with a zero balance because the consumer no longer owes anything to the lender. The tax burden is between the consumer and the IRS. If consumers fail to pay the taxes, they may end up with a tax lien in their history, but it would not be associated with the original account. It would be a new financial obligation.”
Settling debts may still be a wise financial move, despite the fact that you’re likely going to owe the IRS something. That “something” is going to vary depending on your tax bracket and how it impacts your taxable income. Consider this…you paid some amount to the creditor, maybe 20%, maybe more. And, if you paid a debt settlement company to facilitate the settlement process for you then you paid some other percentage to them directly as a fee. When you start adding all of this up, you begin to question just how smart it was to settle the debt rather than just pay it off in full or file bankruptcy.
Credit Reporting Expert, John Ulzheimer, is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. Follow him on Twitter here.