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  1. #1
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    Default Unpaid Credit Card Debt and 1099s

    I'm getting sued for credit card debt and am considering either 1) trying to negotiate with my creditor (lump sum or ongoing monthly payments) 2) filing bankruptcy or 3) letting the creditor get a judgment and planning to stay judgment proof until the judgment expires in 10 years.

    How would I be taxed in each of these situations, in terms of 1099s for canceled debts?

    When would the taxes be due?

    And how does insolvency play into each of them?

  2. #2
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    Default Re: Unpaid Credit Card Debt and 1099s

    1099's don't create tax liability, the action they represent do.

    If a lender forgives any part of the debt, the forgiven part is taxable, though you are given a pass if you're otherwise insolvent.
    Judgement proof isn't a defined concept, it just means that you don't have any assets easily accessible by the judgment creditor.
    Insolvency for avoiding the taxable aspect of the forgiveness is well defined. It involves all your assets, not just those easily accessed by a judgment. (You can easily find the form for computing this on the IRS website).

  3. #3
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    Default Re: Unpaid Credit Card Debt and 1099s

    Quote Quoting ransomedbyfire
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    I'm getting sued for credit card debt and am considering either 1) trying to negotiate with my creditor (lump sum or ongoing monthly payments) 2) filing bankruptcy or 3) letting the creditor get a judgment and planning to stay judgment proof until the judgment expires in 10 years.

    How would I be taxed in each of these situations, in terms of 1099s for canceled debts?

    When would the taxes be due?

    And how does insolvency play into each of them?
    When a debt you owe is discharged (canceled/forgiven) the general rule is that the discharged debt is taxable income to you in the year that the discharge occurs. Note that expiration of the statute of limitations to sue on the debt can result in debt discharge and thus taxable income for you. For a credit card debt, there are two exceptions to that rule. The first is that debts discharged in bankruptcy are not income. Second, the discharged debt is not income to the extent that you were insolvent (your debts exceeded your assets) at the time the discharge occurs. Note that if you avoid having debt included in income under either of these exceptions you might have to make other tax adjustments (reduction in losses carried forward, reduction in basis of assets, etc) to compensate for that. The rules are explained in detail in IRS Publication 4681.

  4. #4
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    Default Re: Unpaid Credit Card Debt and 1099s

    So, I'm assuming that if I negotiate some kind of settlement before January 1, 2018, the amount forgiven would become income for 2017? If I declare bankruptcy in 2018, the discharged amount would not be income for 2018 because of the bankruptcy?

    I'm expecting to have some student loans discharged in April, May, or June of 2018, depending on how fast the final paperwork is accepted.

    Is the calculation of insolvency done in such a way that my degree of insolvency will decrease by the amount of the discharged loans (assuming all else is equal) on the day the loans are discharged?

    If I don't settle or declare bankruptcy, will there be any canceled debt on a 1099? When? What about when a judgment expires?

  5. #5
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    Default Re: Unpaid Credit Card Debt and 1099s

    Quote Quoting ransomedbyfire
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    So, I'm assuming that if I negotiate some kind of settlement before January 1, 2018, the amount forgiven would become income for 2017?
    If you actually complete the settlement and the creditor discharges (forgives the debt) in 2017 then the debt that was discharged is income in 2017. If you negotiate the deal in 2017 but don’t complete it (i.e. do not pay it) until 2018 then the discharge occurs in 2018 and becomes income for 2018.

    Quote Quoting ransomedbyfire
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    If I declare bankruptcy in 2018, the discharged amount would not be income for 2018 because of the bankruptcy?
    Only debt that is actually discharged in bankruptcy is excluded from income under the bankruptcy rule. So if you complete a settlement with the creditor and get the debt discharged before bankruptcy then the debt does not get discharged in the bankruptcy because that debt does not exist any more at the time you file the bankruptcy. (Though if the trustee claims what you paid the creditor as a preference payment that would change things.) But if the debt is discharged in bankruptcy it is not included in taxable income. You may need to make other tax adjustments, though, as I noted in my earlier reply.

    Quote Quoting ransomedbyfire
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    I'm expecting to have some student loans discharged in April, May, or June of 2018, depending on how fast the final paperwork is accepted.

    Is the calculation of insolvency done in such a way that my degree of insolvency will decrease by the amount of the discharged loans (assuming all else is equal) on the day the loans are discharged?
    The computation is done as of the day the debt is discharged. Let me give you a simple example. Joe owes his bank $20,000 on a personal loan. He settles that debt with the bank for $5,000. Thus $15,000 is discharged. Prior to the discharge, his total assets were $50,000 and his total debts (including the personal loan to the bank) were $60,000. Thus, immediately prior to the discharge, he was insolvent as his debts exceeded his assets by $10,000. Immediately after the discharge, his total assets are $45,000 and his total debts are now $40,000. So immediately after the debt, he is no longer insolvent. He is solvent by $5,000 and that $5,000 would then be taxable income as the result of the debt discharge. The remaining $10,000 of discharged debt is not included in his income, but he may have other tax adjustments to make to compensate for that.

    Quote Quoting ransomedbyfire
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    If I don't settle or declare bankruptcy, will there be any canceled debt on a 1099? When? What about when a judgment expires?
    In some circumstances the expiration of the statute of limitations to sue on the debt itself counts a discharge of the debt and is included in your income. That would occur if the statute of limitation actually bars the creditor from suing to collect. There are some state statutes that work that way, and some circumstance in which federal law would have that same effect. In those circumstance it effects a discharge of the debt. Creditors do not often send Forms 1099 for that circumstance (often because they don't know they should), but even if no 1099 is received the taxpayer is required to include it in income anyway. More commonly, though, the statute of limitations does not bar the creditor from suing; it simply gives the debtor an affirmative defense to the claim. In that case, the SOL expiration may be an event of discharge at the time the court actually holds that the SOL applies and the creditor is prevented from pursuing his claim. In that case, if the creditor never sues then the debt may not get discharged by the SOL, but may get discharged when the creditor finally gives up on collecting it. In short, the specific facts matter as to exactly when the debt is effectively discharged in SOL situations.

    The expiration of a judgment does preclude any further collection and would also amount to a discharge of debt for tax purposes. There are no court cases stating that, nor has the IRS expressly stated that, but it follows that would be the case given the effect of the lapse of the judgment, assuming of course that some other event has not already discharged the debt.

  6. #6
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    Default Re: Unpaid Credit Card Debt and 1099s

    Quote Quoting Taxing Matters
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    The computation is done as of the day the debt is discharged. Let me give you a simple example. Joe owes his bank $20,000 on a personal loan. He settles that debt with the bank for $5,000. Thus $15,000 is discharged. Prior to the discharge, his total assets were $50,000 and his total debts (including the personal loan to the bank) were $60,000. Thus, immediately prior to the discharge, he was insolvent as his debts exceeded his assets by $10,000. Immediately after the discharge, his total assets are $45,000 and his total debts are now $40,000. So immediately after the debt, he is no longer insolvent. He is solvent by $5,000 and that $5,000 would then be taxable income as the result of the debt discharge. The remaining $10,000 of discharged debt is not included in his income, but he may have other tax adjustments to make to compensate for that.
    So, would a fairly accurate shortcut for calculating taxable income that results from debt forgiveness be to say that "Your net worth immediately after the debt is forgiven, if it is above zero, becomes taxable income", if we overlook all the other tax law details you've mentioned (that I don't think apply to me anyway)?

  7. #7
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    Default Re: Unpaid Credit Card Debt and 1099s

    Quote Quoting ransomedbyfire
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    So, would a fairly accurate shortcut for calculating taxable income that results from debt forgiveness be to say that "Your net worth immediately after the debt is forgiven, if it is above zero, becomes taxable income", if we overlook all the other tax law details you've mentioned (that I don't think apply to me anyway)?
    I think it is probably accurate to say that the amount that would be included in income under the insolvency test is the lesser of: (1) the amount of the debt discharged or (2) the net worth of the taxpayer immediately after the discharge.

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