One of the biggest benefis of filing bankruptcy as opposed to settling debts separately with your creditors is that any amount saved through a settlement agreement is “forgiven” or “cancelled” debt that is counted as taxable income. At the end of the year, you’ll receive a 1099-C for the amount of forgiven debt. For instance, if you owe a credit card company $100,000.00 and settle for $30,000.00, you will receive a 1099-C from the credit card company for $70,000, which will result in a fat tax bill at the end of the year.
If you file bankruptcy, any debt discharged CANNOT be counted as taxable income. But many creditors will still send you a 1099-C for the discharged debt is not taxable income reportable through a 1099-C. This is obviously a mistake, and many banks and credit card companies just don’t realize the difference. They may have hundreds of in-house lawyers working for them, but hardly any are well-versed in bankruptcy law.
IRS Form 982 – Your Answer to Wrongfully Reported 1099-C Income
So what should you do if you receive a 1099-C? It’s simple – file IRS Form 982, which is the form that debtors get to use to report to the IRS that the cancelled debt is not taxable because it’s discharged. While you may not have to do this if the IRS has all their ducks in a row (they receive notice of your bankruptcy), it’s much easier than filing after the IRS sends you a bill because you didn’t report the income on a 1099-C. You’ll also notice on Form 982 that debts cancelled while you’re insolvent are not considered income; however, the Form 982 test for insolvency can be pretty unfair because it includes any assets in retirement, including brokerage accounts and disability payments.
Just one more reason why filing bankruptcy can be a better option than trying to settle debts with creditors.