Irs Not Forgiving If You Default On Loan Over $600

You may be “forgiven” a debt by a lender, but guess what? You still owe the Internal Revenue Service.

Effective this year, lenders that cancel or write off a delinquent debt of $600 or more are required to notify the IRS and send the debtor a 1099-C tax form stating the amount of debt being discharged. Unless the debtor is in bankruptcy, the IRS views the forgiven debt as income to the debtor - and taxes have to be paid.

The debtor is required to file the 1099-C form along with his income tax return, and pay the applicable rate of income taxes. For example, assuming a 28 percent income tax bracket, a $1,000 credit card debt canceled by the card’s issuer would cost the cardholder $280 in taxes.

Gerri Detweiler, author of “The Ultimate Credit Handbook” and former director of Bankcard Holders of America, a consumer group, worries that the new procedure could make things go from bad to worse for affected consumers.

“When debts are written off, it’s often because the consumers have hit rock bottom and don’t have the money to pay the debt, but now they have to come up with money to pay the IRS and this could result in an even worse credit report,” she said.

“If the taxes are not paid, the IRS may file a tax lien, which is noted on credit reports, and a tax lien is absolutely the worse thing you can have on your credit report.”

The IRS previously considered most canceled debt to be income to the taxpayer, but it generally was up to the taxpayer to report it, which meant it usually went unreported. Now, with lenders required to notify the IRS of canceled debts, the agency’s computers will match the reports to the taxpayers.

If a debtor later decides to repay some or all of the debt, he may seek a refund from the IRS by amending his tax returns.