Cancellation of Debt
When you borrow money and the lender later settles the debt, you have to include the cancelled debt amount as income on your tax return. We call this phantom income as you never actually receive it, but the IRS nevertheless taxes you on this phantom income as if you did receive it as income. In the eyes of the IRS, all the money saved in the credit card settlement is treated as reportable income for tax purposes.
$50,000 Credit Card Debt
Let’s say you have a $50,000 credit card debt, and you settle the debt for $25,000. The IRS will add that debt reduction of $25,000 to your tax return as income. You’ll be paying a lot more in taxes that year.
Mandatory Tax Reporting Requirements
Every lender is required to report the settled debts/cancelled debts in excess of $600 on IRS Form 1099-C, Cancellation of Debt. The IRS cross-checks your tax return with the credit card company’s 1099-C to ensure you report the phantom income. You can expect IRS tax penalties and interest if you forget to report this phantom income voluntarily.
Bankruptcy Is Exempt from IRS Cancellation of Debt Rules
There is no phantom income in bankruptcy. The IRS rules don’t apply. It’s free to chat with me about your options – you can call or text me at 215.551.7109.