Debt Beats

Penalizing forgiveness

In these hard times, credit card companies are often willing to settle delinquent accounts for a fraction of what the debtor actually owes. But that boon comes at a cost: IRS regulations count forgiven debt as income.

If you have managed to get a credit card company to give up on a debt, you should expect to receive a 1099-C in the mail. That form lets you know that the IRS knows exactly how much was forgiven and how much your taxable income increased as a result. USA Today reported in March that the IRS anticipates up to $6.4 million in such taxable "income" this year, up from just $3.9 million in 2010, as the economic downturn staggers on.

If you can prove you were insolvent or went bankrupt legally, you are off the hook for extra taxes. Likewise if your mortgage debt on a principal residence was forgiven because of foreclosure, short sale, or loan modification, provided the amount forgiven was less than $2 million. But the latter exemption is due to a 2007 provision that will expire at the end of 2012 if Congress does not renew it. As an IRS spokesman told USA Today, "no one conceived it would take longer than 2012 to dig out of the mortgage crisis."