Write-offs don’t cause 1099s, but credit card or debt settlements of $600 or usually more do. You can expect a 1099 when you get the amount that you owe reduced which can happen before or after the creditor takes a write-off. Typically, creditors have to send 1099-C forms whenever they forgive $600 or more of debt.
When a customer owes company money, the company carries the debt on its financial statements as an asset, just like a savings bond is an asset for an investor. When the borrower goes a long time without paying the debt, the company has to adjust its finances to show that it’s probably not going to get the money back. This process is called a charge-off or write-off. It doesn’t affect what the borrower owes or the validity of the debt. It’s just a process by which the company admits that it has a problem with the borrower.
When Debt Gets Reduced
Debt reduction is another action that a creditor might take with a long-overdue account. Companies have a couple of reasons to reduce the balance that their customers owe them. Sometimes, a creditor may work with a borrower to negotiate a settlement, agreeing to let him or her out of responsibility for the debt as long as a portion of the debt is paid. Debt forgiveness also happens with the foreclosure process. In some states, for example, a lender can’t come after a borrower if it takes a house, sells it but doesn’t get enough money to cover the loan balance. Then the lender must forgive the remaining debt.
When debt gets forgiven, lenders generally send the borrower and the Internal Revenue Service a “Cancellation of Debt” form called the 1099-C. The tax code requires the creditor to send it when canceling $600 or more of qualifying debt.
When your creditor reduces a debt, the amount is usually subject to income tax, which is why the IRS wants a 1099-C form. However, some reductions aren’t taxable. Taxes apply only to balances that get reduced – cancellation of interest and fees isn’t taxable. Also, debt that was canceled in a foreclosure of a primary residence was tax-free, although this provision expired at the end of 2013. Getting a student loan forgiven in exchange for working in certain public-service jobs is also tax-free. Finally, income tax doesn’t apply to debt that gets canceled when a borrower goes bankrupt or if he has more debts than assets (called insolvency).
Debt Reduction and Credit Reports
Creditors don’t just report debt cancellations to the IRS. They also let the credit reporting bureaus know about it. If you negotiate a settlement that lets you pay off a debt at a reduced amount, it will usually show up as being settled instead of “paid in full” when you check your credit report. Some creditors don’t like to see that you were unable to pay back another creditor in full, so this could hurt your credit score, although its impact usually fades as time goes on.
About the Author
Solomon Poretsky has been a writer since 1996, with experience in the fields of financial services, real estate and technology. Poretsky holds a Bachelor of Arts in political science from Columbia University.
This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.
Published by permission from ConsumerInfo.com, Inc., an Experian company. © 2014 ConsumerInfo.com, Inc. All rights reserved.