Monday, February 23, 2004
Q. Last year I reached a settlement with some of my credit-card companies over my delinquent debts. They agreed to let me pay just part of the debt, and they forgave the rest. Now I have received a tax form saying I must count the forgiven debt as income and pay federal income tax on it. My head is spinning! How is this possible, and how can I deal with it?
A. You'll probably have to pay up.
You got something of value -- whatever you bought with the cards -- and it is taxable, just as if it were wages from a job. This doesn't count as an untaxable gift, such as money received from a parent.
The fact is, you are still coming out ahead -- way ahead. If you are in, say, the 15 percent tax bracket, you'll owe 15 cents in tax for every dollar of forgiven debt. You'll have saved 85 cents by getting the card companies to let you off the hook.
Whether you're entitled to sympathy -- well, that depends on what the card debt was for. If it was to meet a crisis, that's one thing. Obviously, it's something else if it involved a lot of careless spending.
Not to be a scold, but keep in mind that you are not the party who was wronged. Your forgiven debt was paid by someone else. It might have come out of the profits owed to the card companies' shareholders. Or it came from other card users, because unpaid debts are one reason interest rates on credit cards are so high.
Documentation
You should receive a Form 1099-C for every canceled debt over $600, and a copy will go to the IRS. The forgiven amount, shown in Box 2, should be added to "other income" on line 21 of the 1040 form.
Generally, the only ways to escape tax on the forgiven debt are to declare bankruptcy or insolvency, which means that your liabilities exceeded the fair market value of all your assets just before the debts were forgiven. That's a complicated issue, and you probably should get a tax preparer to help you if it applies.
Also, if you can't afford to pay your taxes, you can attach Form 9465 to your return to apply to pay in installments. This is usually granted automatically if the taxpayer owes $10,000 or less.
You'll have to show that you cannot make the payment and that you, and your spouse if you have one, have filed returns properly during the past five years and not had an installment arrangement during that time.
Q. Help me with an IRS problem. My bank failed to send me a 1099 form accounting for the interest I earned on some certificates of deposit in 2001, so I didn't include this income on my tax return for that year. When the IRS notified me of this, I immediately sent a check for the tax owed on the CD income. But now the IRS wants me to pay a penalty and interest.
A. Like the previous reader, you'll have to pay up.
The taxpayer is responsible for filing a correct tax return.
If the bank had sent you a 1099 with incorrect information, you might contend the mistake on your return wasn't your fault -- though taxpayers should check the 1099 figures against those on other statements received during the year.
In this case, you should have known you were missing the 1099. After all, they were your CDs, you received money from them, and the tax return has a clearly marked place for reporting this kind of income.
It's easy to see how you'd feel the IRS is being unduly harsh over an honest mistake.
But think of it this way: You had a number of extra months' use of money you should have used to pay the tax. Ideally, you earned something on that money by keeping it in an interest-bearing account.
If you subtract the interest earned from the penalty and interest the IRS is demanding, the actual cost of this mistake won't seem as bad.
Interest on tax owed but not paid typically ranges from 5 percent to 9 percent, depending on how long ago the tax was due. The late-payment penalty is generally 0.5 percent per month.
XJeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at brownj@phillynews.com.