Will I Pay Taxes To The IRS On Forgiven Debt?

This question is the most confusing issue about debt settlement.

   This web page is not setup for the purpose of advising individuals on how one should file income tax returns, but merely an informational page to direct someone quickly to view exactly what the IRS has to say concerning debt forgiveness. You should consult a tax expert or certified public account concerning any tax issues that you may have.

   The internet is a very useful and powerful tool but needs to be used with caution. Many Americans are reading information concerning subjects written by people in blogs and websites that have not been researched or based on facts. This becomes a major problem for someone who is searching for the truth because like the old saying," if lies or misinformation are repeated enough they eventually will be viewed as the truth."

    The typical articles found on the internet about debt settlement concerning the IRS mentions the "fact" that you will receive a 1099-C and "will" pay income taxes on the amount forgiven as ordinary income. This is true in part but may not the case. What appears in most articles concerning the IRS ruling on debt forgiveness is usually not presented properly. 

    There are many reasons this is reported this way, typically it comes down to one of two reasons. First the author is just passing on misinformation because they didn't know or didn't care to research the subject. Second the author is using the tax issue to get you to use another method that he or she may be promoting other than debt settlement. 

    The only truth is right from the "horse’s mouth" the IRS. But most people have no clue where to look and soon become frustrated, they stop searching only to trust what they heard or read without getting the full facts.

  The section of the IRS code referring to debt forgiveness is 6050P. This section clearly states what organizations are required to file with the IRS and which are not. The November 2004 IRS bulletin gives the final review of 6050P and explains the requirements for discharges of indebtedness by organizations that have a significant trade or business of lending money. 

    Note it's important to understand that the IRS clearly defines in this bulletin what organizations fall under this category. They also included a section concerning debt buyers, (collections companies). On page 786 it mentions that there are three safe harbors under which organizations will be considered not to have a significant trade or business of lending money.

    Commentators for the IRS first mention the subject of acquiring debt other than from the debtor, in other words an organization (debt collector) buying debt from creditor (credit card company). The commentators seemed a bit confused because of an early proposed regulation 6050P-2(e) which says the debt buyers are considered money lenders.
   
    The final regulations in the 2004 bulletin clarifies that a debt obligation acquired from the debtor or any person other than the debtor is subject to reporting under section 6050P(c)(2)(D) if the owner of the obligation (debt buyer) is engaged in a significant trade or business of lending money. Most debt buyers are just that, "debt buyers" not lenders of money.

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NOTICE: This article is not advise concerning filing of personal income tax, the purpose is for information only regarding the IRS code. Any conclusion drawn from this information should be reviewed by a certified tax advisor before filing income tax.