You can find a full description of the various exceptions in IRS publication link opens PDF , but here are one of the common forms of cancelled debt that won't increase your taxable income:. Filing an amended tax return Regardless of whether or not the C will increase your taxable income, you should be aware that the IRS receives a copy of this form as well, so you should fill out an amended tax return to reflect the changes.
If you're claiming one of the allowed exclusions, you still need to tell the IRS why. Adjust your taxable income to include the amount of forgiven debt, and explain in part III how you received a C after you originally filed your return. If you're claiming that the canceled debt shouldn't count as taxable income, you'll also need to file a form link opens PDF to explain the reason.
Unfortunately, you can't e-file an amended tax return. After you fill out the necessary paperwork, you'll need to mail it to the IRS center listed on the amended return instructions link opens PDF.
If the C results in an increase in your taxable income, the amended return form and instructions will guide you through figuring out how much you owe. You can pay any extra tax by mail, online, or by phone, and it's in your best interest to do so as soon as possible -- interest begins to accumulate on any owed balance retroactive to the due date of the tax return, even if you received the necessary tax forms afterward.
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Your input will help us help the world invest, better! Email us at knowledgecenter fool. Thanks -- and Fool on! Keep up with yours using Credit. Once you know why the C is in your mailbox, what do you do with it? The C might seem like just another form to plug into your tax software or give to your accountant.
In some cases, you may not have to do anything. Your creditor should have filled out a C and sent it to the IRS when they forgave the debt. The IRS may do an adjustment on your return automatically and send a notice asking if you agree. It depends on how much debt was discharged. You can use the insolvency worksheet in IRS Publication , but it may be best to work with a tax preparer. If you owed more money than your assets were worth, then — congratulations!
Keep in mind that declaring insolvency may have future tax consequences you may have to reduce the basis of your home or your investments when you sell them , so make sure to ask your tax adviser about that. Sean Fox, co-president of Freedom Debt Relief in Phoenix, said most taxpayers who have debts forgiven can prove they are insolvent. Receiving a C should always mean the debt is canceled and no longer subject to collection. But it may be up to you to make sure. Until , IRS rules allowed creditors to file a C if no payments had been made on a debt for 36 months.
This resulted in many C forms being issued for debts that were delinquent but not actually forgiven. The IRS Taxpayer Advocate Service cited the resulting confusion in its annual reports to Congress as a priority for the agency to clear up. Under an IRS rule change effective in November , creditors are no longer expected to issue a C form merely because debt has gone 36 months without a payment.
If you receive a C for a debt you were not aware was discharged, clarify the status of the debt with the creditor. If they are following the old rule, request that they rescind the C under Internal Revenue Bulletin , T. Rescinding the C will alert the IRS that it was issued in error. If the creditor will not rescind the form or confirm the debt is forgiven, you will need to use the IRS dispute process outlined in publication to show that no taxes are owed.
Unfortunately, creditors have a lot of wiggle room about when to report canceled income to the IRS. Statutes of limitations vary by state and by type of debt, but creditors are not required to file a C at that time since they can continue to try to collect on debt indefinitely.
Consumer advocates argue that under IRS guidelines, creditors should send a C three years after there has been no activity on the debt, but they acknowledge the rules are unclear. If this happens to you, first try calling the creditor. A tax professional can then help you evaluate your options. You can either try to explain to the IRS why it should have been filed a long time ago and make that case as part of your tax return. Or it may be easier to simply use one of the exemptions to avoid paying the amount.
However, the age of the debt can work against taxpayers, Bode says. The time of financial hardship that caused the debt to go unpaid may have passed, leaving the taxpayer with a reduced ability to exclude the debt from income because of insolvency.
Unfortunately, mistakes are common. Often, the discharge date is wrong some banks use a default date of Dec. Start by asking the creditor for a corrected C. First, try contacting the financial institution that settled the debt. You can request it online or by calling In that case, state law will determine how you split the income and report it on your tax returns.
Some states assign it based on how much cash from the loan you each received, Pretsfelder says.
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