The last three years have seen many changes on the financial front. While most people focus on the mortgage market, banks have had problems in other areas. One has resulted in massive write-offs in the credit card market. This raises a host of tax issues for credit card holders.
Everything was going okay. You had a solid job, a home, and…a load of debt. Your mortgage was one thing, but you owed a whopping $17,000 on credit cards. Then the Great Recession hit and you were in trouble. Your salary was cut and suddenly you couldn’t meet the bills. You called the credit card companies and negotiated a reduction in what you owed to $7,000. That cut your monthly payments and really made a difference.
Now are you ready for some really bad news? The tax code in the United States is so out of whack with reality that sometimes a reduction is considered a gain. In this case, the reduction of the credit card debt by $10,000 resulted in a gain from a tax perspective. What does this mean specifically? It means that the IRS considers your $10,000 credit card savings to actually be income to you. Yes, you need to pay income tax on it. Surprise!
The first clue you have a problem should be when you receive a 1099 from the various credit card holders. That being said, you almost assuredly will not get one from all the companies that cut your debt. This might lead you to believe you don’t need to claim the canceled debt from those companies as income. This is a trap. Don’t fall for it. The credit card companies are writing off huge amounts of money to huge numbers of borrowers. Issuing 1099s is pretty low on their “to do” lists. Although they may lag in getting a 1099 to you, they are almost assuredly sending them off to the IRS. If you don’t claim the debt as income, your tax return will be flagged and an audit will occur.
Cutting your credit card debt is a good thing. Just make sure any canceled debt is counted as income on your tax return.
Thomas Ajava is with BestTaxAttorneyinLakeCountyIndiana.com - find the best tax attorney in Lake County, Indiana for tax advice and help dealing with the IRS.
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