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Don’t forget to report 1099-C debt cancellation income

A recent tax court decision reveals just how important it is to not ignore income on Form 1099-C come tax time. The case, TCM 2018-140, involves a taxpayer who received debt discharge to the tune of over $360,000 back in 2010. Lacking any other income for the year, the taxpayer chose to not file a tax return. In 2018, he incurred failure-to-file and failure-to-pay penalties due to his lack of tax reporting.

The tax court tried to throw the taxpayer a proverbial bone by allowing him time to prove that the debt discharge dealt with his primary residence and/or that he was insolvent at the time, but the taxpayer failed to meet the burden of proof for either claim. Had he proven that debt forgiveness income as reported on Form 1009-C was indeed tied to his primary residence, that would have offset the income and made him eligible for tax forgiveness as well.

His failure to pay taxes on the debt discharge income would also have likely become a moot point in the case of insolvency. Insolvency, even after debt forgiveness, is a valid reason for not paying the taxes on the debt discharge income; though it still would have required a valid 1040 filing in the tax year in which the discharge was received.

There are a few key takeaways from this tax court decision. First, always report any 1099 income. Whenever you get a form like this, one has already been sent to the IRS. They are then put on notice of your income. When you fail to report it to them, it’s a red flag that you are potentially hiding something.

Second, when the IRS gives you a grace period to provide proof and documentation of an asserted claim, take advantage of the time to provide it. In this case, the court allowed the taxpayer a further three months to prove claims regarding both insolvency at the time of the debt discharge and tying the debt discharge to a primary residence, but the taxpayer failed to provide documentation on either claim.

Ignoring a problem with the IRS will never make it go away. The only way to face tax-related matters is head-on, preferably with a skilled tax attorney by your side.

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