Forgiveness of Debt Income: 1099-C

Forgiveness of Indebtedness Income: 1099-C

In accordance with the Internal Revenue Code (I.R.C.) 26 U.S.C. Section 6050P, when a debt in an amount of $600 or greater is discharged, it is a taxable gain to the debtor and imposes an obligation of the creditor to file Form 1099-C with the IRS. In other words, historically, if a debt was forgiven against a debtor, you would be taxed on the amount of debt forgiven. So, for example, if your effective income tax rate was 25% and 10,000.00 of indebtedness was forgiven against you, you would be treated as receiving $10,000.00 income, thereby owing the IRS $2,500.00!
One of eight triggering events must occur before an organization is required to file Form 1099–C.
These events are:

  1. Discharge of a business or investment debt in bankruptcy.
  2. Settlement of a debt.
  3. Cessation of collection activity.
  4. Statute of limitations raised as an affirmative defense.
  5. Expiration of the non–payment testing period.
  6. Election of foreclosure remedies.
  7. Probate proceeding.
  8. Debt unenforceable in receivership or foreclosure proceeding.

Prior to Jan. 31 of the year following the occurrence of the triggering event, the creditor must
provide a statement to the debtor.

Mortgage Forgiveness Debt Relief Act of 2007

President Bush signed the Mortgage Forgiveness Debt Relief Act Dec. 20, 2007. Here's a summary of the bill's main provisions.

Income from Discharge of Indebtedness on Principal Residence

This provision is effective Jan. 1, 2007, through Dec. 31, 2009. Under this provision, which adds new IRC section 108(a)(1)(E), the discharge of qualified principal residence indebtedness is excluded from gross income. For purposes of the exclusion, qualified principal residence indebtedness is acquisition indebtedness (to buy, build or improve the residence) up to $2 million ($1 million for Married Filing Separately). The home must be owned and used as a principal residence (within the meaning of section 121). The basis of the home must be reduced (but not below zero) by any debt forgiveness excluded under this provision.

If only a portion of the loan discharged is qualified indebtedness, the exclusion applies only to the amount of debt discharged that exceeds the amount of the loan that exceeds the nonqualified indebtedness.

For example, assume that a taxpayer has a $500,000 loan outstanding on his principal residence, of which $80,000 is equity debt. If $100,000 of the loan amount is discharged, only $20,000 ($100,000 discharged debt — $80,000 equity debt) of the debt discharge qualifies for the exclusion under the new provision.

This provision does not apply to discharge of indebtedness on account of services performed for the lender. Also, an insolvent taxpayer must use the principal residence exclusion instead of the insolvency exception, unless the taxpayer makes an election to apply the insolvency exception instead of the exclusion provision.

Exclusion of Sale of Residence Gain for Surviving Spouses

This provision is effective for sales and exchanges after Dec. 31, 2007. For sales within 2 years of a spouse's death, the capital gain exclusion is increased to $500,000 if the surviving spouse hasn't remarried and the ownership and use tests were met by both taxpayers immediately before the date of death. This provision adds new section 121(b)(4).