What Is Debt Cancellation?
Generally, debt is considered canceled when the lender either forgives or discharges the debt for less than the full amount owed. The canceled debt is the unpaid amount, and the amount canceled may have to be included as income on the taxpayer-borrower's income tax return. The lender is usually required to report the amount of canceled debt to the taxpayer on Form 1099-C.
Canceled debt is generally taxable, however there are exceptions:
- Bankruptcy
- Insolvency - The cancellation takes place when the taxpayer is insolvent, to the extent the taxpayer is insolvent.
- Certain farm debts - If the taxpayer incurred the debt operating a farm, and more than half their income from the prior three years was from farming, and the loan was owed to a lender regularly engaged in lending, the cancelled debt is generally not considered taxable income.
- Non-recourse loan - In a non-recourse loan, the property is repossessed to satisfy the loan balance.
- Purchase price reduction - If the seller reduces debt owed for property purchased, the reduction is generally treated as a purchase price adjustment that reduces basis.
- Student loan - If the student loan is canceled in exchange for public service or the borrower's death or permanent and total disability.
- If the cancellation is treated as a gift, bequest, or inheritance.
- Business debt where the payment would have been a deduction and the taxpayer uses the cash method of accounting.
- The discharge of certain indebtedness of a qualified individual because of the Midwestern disasters. See Publication 4492-B.
Taxable canceled debt is reported as ordinary income, and the income will be reported on different forms depending on what it relates to:
- Nonbusiness - Form 1040 or Form 1040-NR.
- Nonfarm, sole proprietorship - Schedule C (Form 1040).
- Nonfarm, real property rental - Schedule E (Form 1040).
- Farm rental - Form 4835.
- Farm - Schedule F (Form 1040).
The Interactive Tax Assistant available on the IRS website can be used to help determine if the cancelled debt is taxable. The ITA takes you through a series of questions and provides you with responses to tax law questions.
To enter Form 1099-C in TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- Income Menu
- Other Income (W-2G, 2555)
- Cancellation of Debt (1099-C)
- Form 1099-C Cancellation of Debt
When an individual has a debt that has been discharged, the amount that was discharged is generally treated as taxable income to the individual. Under certain circumstances, this amount can be excluded from income, and therefore not taxed. In order to report the exclusion, the taxpayer must file Form 982 with their tax return.
To enter Form 982 in TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- Income Menu
- Other Income (W-2G, 2555)
- Cancellation of Debt (1099-C)
- Form 982 - Reduction of Tax Attributes
To indicate that canceled debt being passed through on Form K-1 (Form 1065) is being excluded pursuant to IRC section 108(1), from the Main Menu of the tax return (Form 1040) select:
- Income Menu
- Other Income (W-2G, 2555)
- Cancellation of Debt (1099-C)
- Protective Section 108(i) Election - answer YES and enter an explanation.
Note: This is a guide on entering cancellation of debt into the TaxSlayer Pro program. This is not intended as tax advice. See below for additional information.
Additional information:
IRS: Home Foreclosure and Debt Cancellation
IRS: Publication 544, Sales and Dispositions of Other Assets
IRS: Publication 908, Bankruptcy Tax Guide
IRS: Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments