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CGCPA, CPA
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is creditor required to report income

Resolved Question:

is a creditor required to report on schedule c the interest that is part of a bad debt cancellation (1099c)

i resolved the net operating loss question previously posted
Submitted: 3 years ago.
Category: Finance
Expert:  CGCPA replied 3 years ago.

Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

First we need to get the concept of creditor/debtor straight so we are speaking the same language and avoid confusion and misunderstanding.

A creditor is any party to whom money is owed. A debtor is the party owing the money. Thus, for example, if you borrow money from a bank to purchase an automobile the bank is the creditor and you are the debtor.

Form 1099C is issued by a creditor to a debtor when an obligation of the debtor to the creditor is canceled or forgiven. With certain exclusions being permitted by law, the debtor must reflect the cancellation of debt on his/her tax return. This is done on Federal form 1040, line 21 (of the debtor)and not on the debtor's Schedule C. The creditor does not recognize an income from this but does recognize a business loss to the extent of the amount of the obligation which is forgiven. Here is a bit of information on this from the IRS. You can read more about this at the IRS web site www.irs since there are specific rules pertaining to home mortgage forgiveness, business debt forgiveness and other forgiven debts.

Topic 431 - Canceled Debt - Is it
Taxable or Not?

In general, if you are liable for a debt that is canceled, forgiven, or
discharged, you must include the canceled amount in gross income unless you meet
an exclusion or exception. However, canceled or forgiven debt is not considered
income if it is intended as a gift or bequest.

A debt includes any indebtedness for which you are personally liable or for
which you are liable only to the extent of the property securing the debt.
Cancellation of all or part of a debt that is secured by property may occur
because of a foreclosure, a repossession, a voluntary return of the property to
the lender, abandonment of the property, or a principal residence loan
modification. You must report any taxable amount of a debt that is canceled, as
ordinary income from the cancellation of debt, on Form 1040 or Form 1040NR and
associated sub-schedules, as advised in IRS Publication 4681, Canceled Debts,
Foreclosures, Repossessions, and Abandonments (for Individuals)
.

Caution: If
your debt is secured by property and that property is taken by the lender in
full or partial satisfaction of your debt, you will be treated as having sold
that property and may have a reportable gain or loss. The gain or loss on such a
deemed sale of your property is a separate issue from whether any canceled debt
also associated with that same property is includable in gross income. See IRS
Publication 544, Sales and Other
Dispositions of Assets
, for detailed information on reporting gain or
loss from repossession, foreclosure or abandonment of property.

If a federal government agency or an applicable financial entity cancels or
forgives a debt you owe of $600 or more, you should receive a Form 1099-C (PDF), Cancellation of
Debt
, showing amounts and other information relating to the
cancellation. The amount of canceled debt is shown in Box 2 of the form.
Taxpayers may also receive a Form 1099-A
(PDF), Acquisition or
Abandonment of Secured Property
.

Canceled Debts that meet the requirements for any of the following exceptions
or exclusions are not taxable.

Canceled Debt
that Qualifies for Exception to Inclusion in Gross Income:


  1. Amounts specifically excluded from income by law such as gifts or bequests
  2. Cancellation of certain qualified student loans
  3. Canceled debt that if paid by a cash basis taxpayer is otherwise deductible
  4. A qualified purchase price reduction given by a seller

Canceled Debt
that Qualifies for Exclusion from Gross Income:


  1. Cancellation of qualified principal residence indebtedness
  2. Debt canceled in a Title 11 bankruptcy case
  3. Debt canceled due to insolvency
  4. Cancellation of qualified farm indebtedness
  5. Cancellation of qualified real property business indebtedness

The exclusion for "qualified principal residence indebtedness," provides
canceled debt tax relief for many American home owners involved in the mortgage
foreclosure crisis currently affecting much of the country. The exclusion allows
taxpayers to exclude up to $2,000,000 ($1,000,000 if married filing separately)
of "qualified principal residence indebtedness".

Generally, if you exclude canceled debt from income under one of the
exclusions listed above, you must also reduce your tax attributes (certain
credits, losses, and basis of assets) by the amount excluded. You must file Form 982 (PDF), Reduction of Tax
Attributes Due to Discharge of Indebtedness (and Section 1082 Basis
Adjustment)
, to report the exclusion and the corresponding reduction of
certain tax attributes.

Refer to Publication
4681
, Canceled Debts,
Foreclosures, Repossessions, and Abandonments (for Individuals)
, for
more detailed information regarding taxability of canceled debt, how to report
it, and related exceptions and exclusions. Additional information can also be
found in Publication 525, Taxable and
Nontaxable Income
.

Customer: replied 3 years ago.
just got back and saw you responded. i think i already figured it out but lets confirm...

i as creditor wrote off on a 1099c for 2011 roughly 146K of which 63,632 is interest, abiet not received, yet it would have been if debtor had paid. my understanding from call to irs today is that i as schedule c filer can only write off what was included as income

do i include as income. this is a business expense and i am legally allowed to issue the 1099c.

i wrote the bad debt off the schedule c . do i write the income in the same way
Expert:  CGCPA replied 3 years ago.

The principal (and any interest that was previously reported as income but not received) is a bad debt. If this was a loan to/for business purposes it is a business bad debt. Otherwise it is a personal bad debt. Business bad debts can only be deducted on Schedule C if this is the nature of your business (making loans). Otherwise, both bad debt types must be claimed as itemized deductions.

Interest received on the loan would have been required to be reported on Schedule B (again, unless this is you business). Yes, you can issue a 1099C but unless your business is a financial institution the issuance is not required.

Here is a piece from the IRS on bad debts and their treatment. It will guide you in gathering the records to support the proper treatment of the bad debt.

Topic 453 - Bad Debt
Deduction

If someone owes you money that you cannot collect, you may have a bad debt.
For a discussion of what constitutes a valid debt, refer to Publication 550, Investment Income
and Expenses
, and Publication
535
, Business Expense.
To deduct a bad debt, you must have previously included the amount in
your income or loaned out your cash. If you are a cash basis taxpayer, you may
not take a bad debt deduction for money you expected to receive but did not (for
example, for money owed to you for services performed, or rent) because that
amount was never included in your income. For a bad debt, you must show that
there was an intention at the time of the transaction to make a loan and not a
gift. If you lend money to a relative or friend with the understanding that it
may not be repaid, it is considered a gift and not a loan.

There are two kinds of bad debts - business and nonbusiness.

Generally, a business bad debt is one that comes from operating your trade or
business.

The following are examples of business bad debts (if previously included in
income):


  • Loans to clients and suppliers
  • Credit sales to customers, or
  • Business loan guarantees

A business deducts its bad debts from gross income when figuring its taxable
income. Business bad debts may be deducted in part or in full. You can claim a
business bad debt using either the specific charge-off method or the
nonaccrual-experience method.

All other bad debts are nonbusiness. Nonbusiness bad debts must be totally
worthless to be deductible. You cannot deduct a partially worthless nonbusiness
bad debt.

A debt becomes worthless when the surrounding facts and circumstances
indicate there is no reasonable expectation of payment. To show that a debt is
worthless, you must establish that you have taken reasonable steps to collect
the debt. It is not necessary to go to court if you can show that a judgment
from the court would be uncollectible. You may take the deduction only in the
year the debt becomes worthless. You do not have to wait until a debt is due to
determine whether it is worthless.

A nonbusiness bad debt is reported as a short-term capital loss in Part 1 on
Form 1040, Schedule D (PDF). It is
subject to the capital loss limitations. A nonbusiness bad debt deduction
requires a separate detailed statement attached to your return.

For more information on nonbusiness bad debts, refer to Publication 550, Investment Income
and Expenses
. For more information on business bad debts, refer to Publication 535, Business
Expenses
.

Customer: replied 3 years ago.
sorry. last -- can i amend prior return and inlude where the interest would have been due? example....investor borrowed for real estate property. paid interst only 2 years then stopped paying. i cancelled debt in same year in one scenerio--'10 i could include and then write off.. in '11 last issue with 1099c's i have not yet included income since no taxes are yet due--but the write off is large and i want to issue 1099c before debtor files bgankruptcy . am i allowed to write off if i inclued in my '11 taxes
Expert:  CGCPA replied 3 years ago.
You can go back and amend the earlier returns and that would be correct. It will also provide greater deduction for the 2011 returns. However, you should also take two points into account. Amending the returns may cost you additional taxes and this would result in interest and penalties being charged. It is also necessary to take into account the income you will show on your 2011 return. Will this have a greater benefit than claiming the bad debt loss in an amended 2010 return?
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