A 2007 federal law relating to debt may hit some people in the pocketbooks this tax season.
Last year, the bottomed-out economy left many jobless, some homeless and others feeling threatened by bill collectors.
David Stoker, of Woodstock-based Currie & Stoker, said many people faced with unfortunate financial situations in 2009 may get a surprising tax document under the Debt Cancellation law, which is attached to the 2007 Mortgage Debt Relief Act.
People who tried to deal with financial hardships by settling debts in 2009 might find that it’s come back to haunt them.
According to publication 4681 by the IRS, those who cancel a debt with a qualified institution, which includes banks and credit unions, can be taxed on the difference between the amount owed and the amount for which the creditor settled. The creditor is supposed to notify the taxpayer and the IRS by issuing a 1099-C (a 1099-A form also can be issued but typically is for abandonments).
“It’s been around, but it’s never been imposed,” Stoker said, adding he believes the pressure of enforcement is coming from the Internal Revenue Service, directed at creditors. “You’re always supposed to claim it, but you weren’t always getting a 1099. If you don’t get a 1099, there’s no documentation, so there’s no way the IRS knows to make you pay. So the IRS is putting pressure on the financial institutions to issue the 1099s now.”
Radio host and New York Times best-selling author of financial help books, Dave Ramsey, said he believes many Americans will be affected by this law, as circumstances, such as the declining stock market, company closures and the stagnant real estate market, left many people e financially strapped.
“If you borrow money from a commercial lender, and the lender forgives or cancels the debt, you may have to include the cancelled amount in income for tax purposes, depending upon the circumstances,” Ramsey said. “The lender is ‘usually’ required to report the amount of the cancelled debt to you and the IRS on a form 1099-C.”
People who settled a credit card debt, for instance, may be liable for the taxes on the difference of what was paid and what was owed.
Stoker offered an example of someone settling a $20,000 with an agreement to pay off $5,000 of the debt. “They will give a 1099 for the other $15,000, and you owe income tax on the whole $15,000,” he said. “Most people don’t understand the consequences.”
There are exclusions, so contact a tax professional or the IRS to learn more.
In some cases, a foreclosure might also result in taxpayers receiving 1099 forms.
While someone who faced foreclosure of a primary residence will have no worries on paying taxes on that house—due to the Mortgage Debt Relief Act of 2007—those who had a second home foreclosed on can expect to pay taxes.
The act, however, only offers tax relief on mortgage debt of up to $1 million for single or married filing separately and $2 million for married filing jointly. The act applies to taxes for the period 2007-2012.
“You may owe the tax on the difference between the mortgage and what they sold it for,” Stoker said. “So if you had a $200,000 mortgage on a rental house, and they sold it for $100,000, you could potentially owe tax on the other $100,000.”
Mark Yates, of Woodstock’s Yates and Company, said filings dealing with debt cancellation can get complicated and may result in a notice from the IRS, so it’s wise to seek advice from a professional.
“In that particular area, they can expect a greater chance of getting some inquiry from the IRS,” Yates said. “Depending on the debt and how it’s handled, in some cases the debt is eliminated and they don’t have to pay taxes, but they have to reduce their tax attributes to some assets to account for that.
“In other words, ‘We’re not going to make you pay taxes on it now, but you might have to pay taxes on it later,’” Yates said.”The bottom line is, it can be a complicated area. There may be some things they don’t think about as individuals.”
Even if a 1099 form hasn’t arrived by its due date, Michelle Fox, of Safeguard Business Services, a mobile accountant based in Cherokee County, said that doesn’t mean it’s not coming.
“Be patient and wait, because, as soon as you file your tax return, it’s going to show up at your door,” Fox said. “If they don’t get one in a reasonable amount of time (by the end of February), they can contact the Internal Revenue Service.
“My feeling is these companies are going to be a little overwhelmed with more of these than they are accustomed to filing,” she said.
Mark Green, a spokesman for the IRS, said 1099s must be sent by Jan. 31, and penalties to the employer can be stiff for failing to do so.
Ramsey said if someone finds out he or she owes taxes, it’s important to understand what’s owed.
“If you owe state or federal taxes, you need to make sure that you contact them and get a full understanding of the amount owed and why. Once the lines of communication are established, then people can begin to work on a repayment plan that fits their budget and makes sense,” Ramsey said. “The worse thing that people can do is to ‘agree’ to a repayment plan that does not make sense for them. Do a budget before you agree to anything, so you know what you can afford to pay.”
Tax laws can be confusing for the average person, and experts say this is the year to take advantage of having a professional do the work. They stay abreast of ever-changing tax laws through mandatory continuing education, e-mail and mailing lists, IRS mailing lists and trade publications.
Yates, a former IRS agent, said his company has seen an increased presence of agents making contact and conducting audits, so it’s important to have the documentation to back up a tax return.
“We have seen an increase in inquiries by the IRS in the last couple of years, compared to the last 20 years,” he said. “They’ve improved their reporting to know what to send out, (and) they have beefed up audits and notices.”
