Debt can remain on creditors’ books for more than 6 months before they take action to write off the debt. If this occurs, the creditor will try to get the money from you or forgive you of your debt, which is often the case with bankruptcy. If a creditor does forgive your debt, you must report this debt as income on your tax returns. In addition, you must pay the income tax on the debt, since the creditor will be reporting a loss and taking a deduction.
Look for a letter referred to as a 1099-C in the mail early in the year. The IRS requires this letter in order for a company to forgive a debt. It is the creditor’s way of telling the IRS that they had a bad debt with you (or your organization) and they should be able to charge off or write off the amount of the debt.
Review your bankruptcy judgment if you had a bankruptcy. The amount on the judgment should match the amount on the Form 1099-C sent in to the IRS by the creditors.
Include the payment amount in your net income, since it will be taxed as income. Specifically, debt forgiveness is usually presented in the "other gains and losses" category of the income statement.
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