When did paying off debt?

Question

Become income?

In October of 2005, I paid off 2 credit cards. I owed $5,000.00 on one, they settled for $4,000.00 and about the same with other card. This past year, 2007, I get a notice from the IRS calling what I didn't pay "income" and I have to pay taxes on the $2,000.00
I was not told by the credit card companies they would be sending a 1099 to the IRS and that it would be considered income, so I had no idea. I also never received a 1099 from either credit card company.

Not certain if this matters, but I used money from my home equity line of credit to pay these credit cards off.

Any help or information about this would be greatly appreciated!

Answer 1

Sad, but true. Unless you filed for bankruptcy protection:

Surprise! Forgiveness of a Debt is Taxable Income

IRC §61 - Gross Income Defined
61(a) GENERAL DEFINITION. --Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:

61(a)(12) Income from discharge of indebtedness;

Answer 2

When you borrowed the money from the credit card, you did not have to pay income tax on it. But since you now will not be paying that money back, the IRS considers this income.

Amend your return and include the cancelled debt on Line 21 of Form 1040 as "Cancelled debt". It is not subject to Social Security or Medicare taxes.

Or, if you agree with the computation done for you by the IRS, just send in the tax you owe, plus interest and possibly a penalty as indicated in the letter you received.

Whether you received the 1099, or how the debt was repaid, does not affect the tax you owe on the cancelled debt.

Answer 3

Here is the info from an IRS publication:
Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. A debt includes any indebtedness for which you are liable or which attaches to property you hold. If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21 (Other Income).

So the canceled debt is to be included as income in the year in which it was canceled.
Contact the debt card company for the copy of 1099 (for canceled debt). Or may be you can get it from IRS (contact IRS to find out what to do if you don't have 1099). File amended tax return Form 1040X for the year.

Answer 4

It's been the law for a long time - maybe you just didn't have any debt cancelled before. And no, it doesn't matter that you paid it off with money from a home equity line of credit.

The basis for the law is that you made $5000 worth of purchases but only paid for $4000 of them, so you essentially got $1000 free and now you have to pay tax on it.

Answer 5

technically they can get away with that because you got use of their money and it didnt get paid back in the settlement.
they are allowed to report this to the IRS via form 1099 and many creditors do. i am not sure whether or not they are required by IRS reporting regulations to actually send you a 1099 form for your records, you would have to check with a tax attorney on that. anyways, i bet if you called them on it, they would have records that showed the 1099's got sent... but probably didnt... you may have to file an amendend return if the IRS pushes the issue.

good luck

Answer 6

The reason is actually very simple. Although loans are not taxable income since they are repaid, if you don't repay in full the amount you didn't repay IS income. You got $5,000 and paid back $4,000. The $1,000 difference is OBVIOUSLY income to you. Plain and simple!

Answer 7

If you were insolvent at the time of the cancellation of debt, you can exclude from income the cancellation of debt to the extent you were insolvent (Liabilities exceed Assets)

Answer 8

i used to work for a collection company. whenever you setle a debt, the portion in which you do not pay (i.e. the amount you settle and done pay), you must pay taxes to the IRS for that portion. in your case, if teh original debt was $5K and you paid $4K, you must pay taxes on that $1K.