My Charge-Off Sent to the IRS

unhappy elderly woman looking at bills.
•••   redhumv / Getty Images

A charge-off usually happens after you’ve been delinquent on a debt for 180 days or six months. It is the credit card issuer's way of taking a loss on the debt. In their accounting books, they’ve written it off as uncollectible, and they no longer count the debt as an asset. Creditors can continue collecting on a charge-off until you pay, even though it's been charged-off.

Canceled Charge-Off

In some circumstances, the creditor may decide to cancel the debt completely. When this happens, you no longer have a responsibility to pay the debt. While you may be relieved to no longer have this obligation, there is an impact on your taxes.

When creditors cancel debts, they are required to report the canceled amount (if it's over $600) to the IRS using Form 1099-C cancellation of debt.

The IRS considers any canceled debt as income, and you’re to report the income on your tax return for that year. It could increase your tax liability and result in a smaller income tax refund or even require you to pay additional income taxes to the IRS. Because the creditor has sent a copy of the cancellation of debt form to the IRS, the IRS is expecting you to include the amount on your tax return. Your return may not be accepted, or you may get a bill from the IRS if you fail to include the amount.

Depending on your income, tax bracket, filing status, and other tax factors, the canceled debt may only affect your taxes minimally. It's not likely that you'll have to pay the full amount of the cancellation to the IRS.

Settled Charge-Offs

You’re also required to include canceled debt on your taxes when a charge-off is settled because the creditor cancels a portion of the debt in the settlement offer. A settlement is when you negotiate with the creditor to pay just a percentage of the outstanding balance to satisfy the full debt.

Insolvency Exception

You may be able to get an exception for including the canceled debt as taxable income on your tax return. If you were insolvent, meaning you had a negative net worth, at the time the debt was canceled, you might not have to report all or part of the charge-off to the IRS. You must file IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to claim the insolvency exemption. For this, you'll need to have a list of your assets and liabilities at the time the debt was canceled.

Get a Tax Preparer Involved

It's always in your best interest to seek the help of a tax professional, especially when you're dealing with unfamiliar tax situations and forms. The tax preparer can help ensure your taxes are filed correctly whether that means including the canceled debt as income or filing for the insolvency exception.

You don't want to be the tax preparer's guinea pig. When you're choosing a tax professional, ask if they have experience working with taxpayers who've had to file a 1099-C Form or claim an insolvency exception. You want to have an experienced tax professional help with your taxes.