Debt Forgiveness: It's Taxable Income

Chris asks when you get issued a 1099-C for cancelled debt, do you still owe the debt?

QUESTION: Chris asks when you get issued a 1099-C for cancelled debt, do you still owe the debt?

ANSWER: No. Debt forgiveness, with the exception of your personal residence in most cases, is taxable income. If you owe MasterCard $10,000 and you don’t pay them for a while because you’re broke and they come along and say, “Hey, we’ll take $4,000 as settlement in full for the $10,000 debt,” the $6,000 debt forgiveness—the amount they didn’t make you pay—is taxable income, and they send you a 1099-C on that for cancelled debt. They’re required to by law, and you’re required to pay taxes then on that $6,000.

Does that mean you still owe the money? No, it does not. You don’t owe the money. The debt was cancelled. As a matter of fact, it’s an indication you don’t owe the difference. However, any time you’re settling with a debt that you owe and you’re settling for less than what you owe, then you need to get the amount you’re settling for in writing so you have proof because their memories are bad. Some of them are crooks. A lot of them are scum, so you need it in writing. In writing. In writing. I had an old lawyer friend of mine who said if it’s not in writing, it didn’t happen. In writing. Get a letter or a fax or an email or something from them. I don’t care what it is, but some kind of proof that they have accepted $4,000 in our example for this $10,000 debt.

The second thing is when you’re settling a debt, never, ever, ever, ever, ever, ever, ever give them electronic access to your checking account when you’re dealing with a collector. I do have people who have electronic access to my checking account. They’re called my electric company. It’s my insurance company. My mutual fund company. They auto-draft my checking account—all of my utilities do. That’s fine. There’s nothing wrong with that at all. We actually have a thing if you buy a book here and want to use a check rather than a debit card over the phone, we can draft your checking account. We do that all the time. There’s nothing wrong with that at all, but don’t let somebody in the collections business have access to your checking account because, as I mentioned earlier, many of them are not nice people. They’re scummy, and they’ll clean your account out. Oh, they settled for $300, but they take $700, and then your rent check bounces. “Oh, but Dave, they’re not supposed to do that.” I know they’re not supposed to do that. Try collecting money from a collector. See how that works for you.

So don’t allow them to have electronic access to your checking account and get it in writing when you’re settling the debt, and yes, the amount that is forgiven is taxable income. It doesn’t mean you owe the money anymore, but it does mean that you are going to have to pay taxes on that amount of money.