Form 1099-C: Cancellation of Debt

If you received a 1099-C, the first question you ask is: ‘Do I have to include this in my taxable income?’ Well, the answer is ‘it depends’. Not what you want to hear but there are a lot of variables involved in answering this question. For those of you receiving this document, more than 90% of the time the answer will be ‘NO’.  Even though you do not have to include the assigned income in your taxable sources, you still need to report why you do not have to include the cancellation of debt in your income to the Internal Revenue Service. This article is written to help you confirm the ‘NO’ answer and to teach how to properly document and report the exclusion to the Internal Revenue Service.

This is a simple process to document and determine the correct procedure to report the outcome to the IRS. The following are the five steps you need to take. In each step I explain how you determine the answer and how to document the results. Remember, no matter if the answer is ‘YES’ or ‘NO’ you still have to document the outcome to the IRS.

Please open this PDF file Form 1099-C  in a separate window and use your ALT and TAB keys to flip between this article and the screen shot of the Form 1099-C. Just put your thumb on the ALT key and third index finger on the TAB key.  Hold down the ALT key with your thumb and just click the TAB key and your software will flip between the two windows. When you let go of the ALT key, the window goes full size.

First Step – Personal or Business 

The very first step is to determine whether the cancellation of debt is personal or business. The reason for this is because cancellation of debt has a significantly greater chance of not being included in your income if the debt is classified as personal. The easiest way to determine one or the other is by looking at Form 1099-C and see if DEBTOR’S identification number (left hand side, about 1/3 of the way down) is your personal social security number or your business’s federal identification number. The following two sections describe the general process involved in either classification.


When the debt is of personal nature, such as a credit card debt or an auto loan, the primary key question is the type of debt.  Is this debt recourse (you are personally liable) or nonrecourse debt which is debt that you have no legal obligation to pay? If you do not understand the terms recourse and nonrecourse, I have written a highly detailed explanation of the two terms in this article: Recourse and Nonrecourse Types of Loans. Often the form will tell you from the creditor’s perspective whether it is recourse or not. If Block 5 is checked on the form, then you have recourse debt cancellation. 

In almost every situation associated with Form 1099-C, the type of debt is indeed recourse.  Nonrecourse debt is rare when receiving a 1099-C.


If the DEBTOR’S identification number belongs to your business operation, then odds are that you will have to include this income in your business tax return. Unlike personal debt which has several exceptions and several exclusions, business debt has very few exceptions or exclusions from inclusion in your income. The primary issue is the form of business this debt is tied to for reporting purposes. The only time it is directly included on your personal Form 1040 is if you operate a Sole Proprietorship. Then this cancellation of debt is included on your Schedule C as other income. 

If the identification number is other than a sole proprietorship number, then this income is reported on the respected entity’s tax return. If you need more help in understanding the various entities, please read: Types of Business Entities.

Just because the business has to report this income doesn’t mean that you can’t get an offset, you still may be entitled to an adjustment of some sort. You just have to understand the rules and document properly to reduce this income. Please continue to follow the steps below to see if you can reduce the income and by how much.

Remember, this step is primarily to determine if the cancellation of debt is personal or business. If personal, is it recourse or nonrecourse debt? If business, which form is used to report the income and any possible adjustment you are entitled to take. 

Second Step – Do You Still Retain The Property? 

The second step in this process deals with the property associated with the debt. Ask yourself, did I receive any property as a result of this debt? There are two sub-steps to this issue. The first is, was the debt used to purchase property, and the second is ‘Do I still have possession of the property?’ 

The most common example is an auto loan. Here money was lent to you to purchase a car. The title had a lien on it and the car was the collateral. In most cases, the answer to the primary question of property received because of the debt is yes. Some of the reasons for a no include: 

  • Using a credit card to purchase consumables or a vacation. There is no physical property associated with the debt today. It is all long gone.
  • Borrowing money from a finance company to cover receivables. Those receivables are non-existent today because they have been paid or they no longer exist.
  • The debt is associated with penalties or interest accrued on the original principle. 

The second part of this question is if the first part is ‘YES’ (debt is associated with a physical item) then do you still have the item in your possession? Odds are that this is a no. Typically debt that has a physical item as collateral is partially satisfied by repossessing the item and selling that item in the market. Examples of this include repossession of autos, foreclosure on a home, and the removal of equipment in a business loan. Examples of continuing to retain the physical item include the purchase of furniture, jewelry, and fixtures (appliances, wall decorations, and office equipment).  

In general, if you continue to retain physical control over the item associated with the debt, then you will need to include the cancellation of debt in your income. You may still qualify for the exceptions and exclusions. It just means you need to do a little more paperwork. 

In most situations, you no longer have the item in your possession that was purchased with the debt in question. Therefore, the process will be a lot easier to report and again, you will most likely exclude of the cancellation of debt from your income. 

Third Step – Identify the Event Code

Look in Block 6 of the Form 1099-C. What is the event code? An event code identifies some form of trigger to create the cancellation of debt. The following explain the respective meanings of the event codes associated with cancellation of debt: 

  • A  Bankruptcy – this is a result of the formal process related to bankruptcy in the federal court system. In general, this code will absolve you of having to include the dollar value in your income. You still must report the value and then identify an exclusion equal to the same amount due to bankruptcy.
  • B  Other Judicial Relief – again, as in bankruptcy there is formal court proceeding (usually at the state’s circuit court level) that absolves you from this debt or a portion of the debt. Examples of this include improper equipment, contractual adjustment, poorly worded or documented financing agreement and others. Just as in bankruptcy, the code will absolve you of having to include the income in your taxable income but you must still document and report this to the Internal Revenue Service.
  • C  Statue of Limitations or Expiration of Deficiency Period – many states only allow a period of two years from the last transaction date for the creditor to act on the debt issue. Failure to act by the creditor limits enforcement options for the creditor. It does not absolve the debtor of the balance of the loan. You don’t see this too often but this is not uncommon in consumer loans or medical debts.  In almost all cases, the debtor does not have to include this dollar amount in their income due to one of the exclusions described below. However, it still must be reported to the IRS and documented properly.
  • D  Foreclosure – if this is marked, review the foreclosure process further down in this article.
  • E  Debt Relief from Probate – this is rare and usually associated with the identification number of an estate or the social security number of the deceased. If this is the code, I suggest you seek professional help from a CPA to not only document this but to process the reporting correctly. This will most likely include reporting the income via Form 1041 – Income Tax Return for Estates and administering the exclusion under state law through the state’s circuit court system.
  • F  By Agreement – when both the creditor and the debtor agree to a reduction in the principle of the debt in exchange for early payment or some other arrangement (additional collateral, automatic payments from compensation, etc.) the debtor does generally have to include this dollar amount in their income and there are limited exceptions and exclusions.
  • G  Policy Decision to Discontinue Collection – this particular code is more common than what many folks may think. Based on the respective circumstances, you may have to include the income in your taxable income.
  • H  Expiration of Nonpayment Testing Period – if coded with an ‘H’, please seek guidance from a Certified Public Accountant. This code is used by financial institutions that were qualified as creditors in a bankruptcy discharge.  The discharge was not a full discharge and therefore a repayment plan exists. During the period of repayment, the trustee for your case did not receive enough funds to allocate out to the group of creditors and therefore nonpayment during the testing period. The testing period is normally 36 or more months in duration.
  • I  Other Actual Discharge Before Identifiable Event – this is a rare code  Please seek guidance from a Certified Public Accountant.

The code is necessary in determining the correct process to use in reporting the event to the IRS. Remember, no matter what the outcome, it must be reported to the IRS and your state as required.

Fourth Step – Exceptions and Exclusions 

Now comes the good part about all this. Even though you have received a Form 1099-C, you have many opportunities to offset this dollar amount due to certain circumstances. The Internal Revenue Service uses the terms ‘Exceptions’ and ‘Exclusions’. Exceptions are basically written into the Code as dictated by Congress. Exclusions are based on other forms of law such as bankruptcy or due to financial circumstances, most notably insolvency. Both bankruptcy and insolvency are covered in extreme detail in this article: Insolvency and Bankruptcy – Know the Difference.


There are five exceptions to inclusion of the cancellation of debt as taxable income. All of these exceptions are related to Congressional mandates to assist in social change/compliance. The following are the respected exceptions and the reasoning:

  • Gifts, Bequests, Devises, and Inheritances – there are often loans between family members and when the creditor dies (s)he may forgive the debt. This is very common and quite normal.  Even before death, the creditor may gift the forgiveness of debt to the debtor. Congress has always allowed the write-up of assets to current fair market value upon death. As for gifts, the creditor has a $600,000 exclusion when making gifts and therefore the debt may be forgiven without any tax implications to either party.
  • Student Loans – if you received a student loan from a government or non-profit agency and provided services in exchange for cancellation of the debt (similar to a government based offset or forgiveness program), you will not have to include this income in your taxable income. These also include those involved in the education repayment loan assistance program requiring you to provide primary health care services to designated areas. These programs were designed to provide professional services (mostly health and legal) to depressed and poorer areas of the country where there is little economic gain for new entries into the local population. 
  • Deductible Debt – if your loan was canceled and you would have been entitled to deduct this debt from your taxes (typically in the business arena); the cancellation would also qualify as non-inclusive in your taxable income.
  • Price Reduced after Purchase – if the debt cancellation is a result of a seller purchase price reduction after the original transaction (typically associated with a sudden decrease in value for a particular asset purchased using debt), the reduction of the sales price amount is not included in your income. However, the basis for the particular asset must also be reduced to reflect the adjusted purchase price paid. This is an economic value issue whereby the seller is agreeing to modify the value of the loan in exchange for reducing the profit and therefore the correlating taxable income. 
  • Home Affordable Modification Program (HAMP) – those incentive payments made to reduce your principle portion of your mortgage and included in the cancellation of debt are generally an exception and those amounts are not included in your taxable income.


Just as in exceptions, there are five exclusions allowed under the code. The first two are easy to understand but the remaining three deal with real property issues and therefore any retained control over the underlying asset requires the taxpayer to adjust the basis in the associated asset by the same amount excluded from taxable income.

  • Bankruptcy – any dollar amount granted under Chapter 7 (liquidation), 11 (business reorganization), 13 (reorganization) is excluded from income on your tax return if reported as cancellation of debt.
  • Insolvency – when a debtor has more debt and financial obligations than financial resources (mostly cash) to pay these bills, the debtor’s financial condition is referred to as insolvent. The extent of insolvency is the maximum dollar amount the debtor is allowed to offset the reported dollar value of the cancellation of debt. In most situations related to exclusions, this one will be the most common. To fully understand what insolvency means, please read Insolvency and Bankruptcy – Know the Difference. The following are two examples to assist you in understanding this form of exclusion:
    1. Taxpayer receives a 1099-C related to a repossession of their auto. The bank identifies $3,000 of unpaid balance associated with the balance of the loan. The taxpayer has $2,000 of cash and associated bills due of $8,000 including the cancellation of debt amount. Therefore, the taxpayer still has a balance of $6,000 remaining in various debts if using the cash to pay on the bills due. The taxpayer is insolvent to the tune of $6,000. Therefore, the taxpayer is allowed to offset the debt by reporting this information to the IRS.
    2. Taxpayer receives a 1099-C related to a repossession of their auto. The bank identifies $3,000 of unpaid balance associated with the balance of the loan. Taxpayer has various assets worth about $12,000 including cash, some equipment, an insurance claim that is payable to him and prepaid rent for the following month. On the other side, he owes $14,000 in various medical bills, utility bills, taxes to different government entities and the $3,000 to the bank for the remaining balance on the unpaid loan. In this cash, the taxpayer is insolvent by $2,000. The taxpayer is allowed to exclude $2,000 of the cancellation of debt.  The remaining balance of $1,000 must be included in the taxpayer’s income.
  • Qualified Farm Indebtedness – if the taxpayer is a farmer and earns more than 50% of his income from the farm and the loan is from a qualified lender (usually a bank or a finance company), the taxpayer is allowed to offset the cancellation of debt based on meeting these conditions. There are restrictions associated with using this exclusion and the farmer should consult with their CPA to confirm the proper use of this exclusion.
  • Qualified Real Property Business Indebtedness – similar to the farm exclusion, if the taxpayer borrowed money to purchase real property used in his trade or business and that loan was incurred prior to 1993, the taxpayer will be allowed to offset the cancellation of debt with an equal amount of value. There will be an adjustment to the basis of the property and any future sale will more than likely create a higher capital gain reflected in the dollar amount of the offset.
  • Qualified Principal Residence Indebtedness – this exclusion refers to your home. If your mortgage company sends you a 1099-C related to a foreclosure proceeding or as a mortgage loan adjustment, then may exclude from income this dollar figure. If you retain the property, then you must adjust the basis downward equal to the same amount you exclude from your income. This particular exclusion is restrictive and is only available for the loan amounts associated with the original mortgage loans and any refinancing to the extent of the original mortgage loan and money used to improve your home (renovations, restoration, and/or additions).

Up in step two above, I cover the subject of retention of the physical property. If you use an exclusion from above and retain the property, you must adjust the basis of the property (reduce the basis) to reflect the dollar amount you exclude from your income.  In general, using bankruptcy or insolvency requires you to lose the rights to ownership of the property. Whereas; the qualified indebtedness group identified above allows you to continue to own and use the property.

Of the above exclusions, the most commonly used exclusion is insolvency. This is due to the nature of how economic activities work.  Most people fail to pay their debts because of extenuating circumstances and therefore do not have the cash available to make payments. They slow pay or ignore those debts that do not affect their immediate living conditions i.e. everyone pays their utility bills, fuel bills, rent and food but will delay or ignore medical bills or long term loans.

Fifth Step – Documentation 

Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness is the form used by the taxpayer to report to the IRS any offset to income included in the tax return (in most cases). Whether this is a business or the more common personal situation, you must use this form to exclude any income on your return or if applicable, file an attachment explaining the adjustment. Form 982 is divided into two main parts. The first part identifies the particular exception or exclusion you are exercising to adjust the amount reported via Form 1099-C.  

In the first step above, you are identifying whether the cancellation of debt is personal or business. Form 982 has an identification section at the very top of the form. You must identify your name or business name and the identification number (usually your social security number). This should match the 1099-C information. 

In Step Two, do you still have the physical property? If yes, you will definitely have to fill out Part II of Form 982. If not, you are merely filling out Part I and it is straight forward.  

In Step Three above, you must know your event code. The event code points to how you answer line one of Part I of Form 982.  

The fourth step identifies the particular reporting format for the cancellation of debt. If the debt meets one of the exclusions, you must file Form 982, if it meets one of the exceptions; the reporting format depends on the exception. The following is the best reporting format to follow depending on the exception: 

  • Gifts, Bequests and Inheritances – attach a note to your return identifying the particulars related to the gift/bequest/inheritance and on Line 21 of your Form 1040, state ‘See Statement Attached’. For your attachment, indicate line number and the title. The following are two examples:
    • Form 1040, Line 21 – Other Income:  Form 1099-C Cancellation of Debt related to ‘Gift’  – a loan was provided to me from my parents: John Q. Public and Mary A. Public residing at 123 Main Street, Uptown, NY 11111. This loan was dated in May of 2007 and on May 14, 2013, John and Mary agreed to cancel the debt and in turn make this a gift to me. John and Mary filed the appropriate gift tax returns as required by the Code.  Total gift was $27,200. Therefore, total exception to the cancellation of the debt is $27,200.
    • Form 1040, Line 21 Other Income:  Form 1099-C Cancellation of Debt related to ‘Bequest’ –  on May 14, 2013, my father passed away. His legal name is John Q. Public. His address of record is 123 Main Street, Uptown, NY 11111. In accordance with the terms of his will (copy attached), my father bequest the forgiveness of a debt dated May 1, 2007. The forgiveness of debt as a bequest is an exception to inclusion of cancellation of debt as income to me and therefore, the offset to Form 1099-C is $27,200. In accordance with the Circuit Court in the County of Greatness, New York, the will is filed in Deed Book number 10,201 on page 544. The appointed Executrix of the Estate is Mary P. Statesmen, daughter of John Q. Public. The estate’s identification number is 71-1234567 (as reported on Form 1099-C). Please communicate with the estate for confirmation of the bequest via the address of record.
  • Student Loans – as in gifts, bequests, and inheritances attach a note to the return and use the format as identified above. On Line 21 of Form 1040, write ‘See Statement Attached’. In your statement indicate times of service, location, and any particulars so the IRS may confirm your exception. Particulars can be contacts, phone numbers, copies of related documents such as your contract etc.
  • Deductible Debt – typically a business issue, the statement is attached to the Other Income line of the respected business form you file. These include Schedule C, E or F.  If a legal separate tax entity, file the statement with the appropriate tax return.
  • The two remaining exceptions use Form 982 to report the adjustment to the cancellation of debt. 

If the taxpayer qualifies using exclusions, then Form 982 is required. As stated earlier, the most common adjustment is insolvency. Check 1b and insert the dollar adjustment amount on Line 2. If you still retain the physical property, you must fill out Part II of Form 982. The most common line in Part II is Line 10a. 

Attach Form 982 to your tax return. 

Summary – Form 1099-C

That is it! Remember in the opening paragraph it was stated that almost 90% of all cancellation of debt is not included. The most common reasons are insolvency or bankruptcy which is reported via Form 982 and attached to your tax return. Other reasons are exceptions and in those situations, a statement is customarily attached to the return identifying the details of the exception.  

Overall, the taxpayer must include cancellation of debt in income or document any adjustment to the cancellation of debt. Prior to documenting the adjustment, determine if the debt is personal or business. This determines which tax return is used to report this information. Next, determine recourse or nonrecourse. This assists in determining the correct tax form to use in reporting the cancellation of debt.  Next, answer a key question, do you still maintain title and control over the asset. If yes; any cancellation of debt not included in income must reduce the basis of the asset held. 

The event code will point the taxpayer to the proper reporting format to the IRS. If the cancellation of debt meets one of the exceptions, more than likely you will need to attach a detailed note to your tax return identifying the particulars involved in your case. If the debt falls within one of the exclusions, then Form 982 must be attached to the return with the information filled out in Part I and if applicable, Part II.  Part II is applicable if you still have title and physical control over the asset. 

Overall, most readers of this article will not have to include cancellation of debt as income, but you must document the respected exceptions and exclusions to satisfy the Internal Revenue Code requirements. Act on Knowledge.

© 2014 – 2022, David J Hoare MSA. All rights reserved.

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