A 1099-C is an IRS tax form that creditors file when they cancel or forgive $600 or more of debt. The form reports the cancelled debt as cancellation-of-debt income, which is generally taxable to you. You receive a copy of the 1099-C; the IRS receives a copy too. You typically receive a 1099-C if you settled a credit card for less than the full amount or had a debt discharged in non-bankruptcy circumstances.

What triggers a 1099-C. Settlement of a debt for less than the full amount; charge-off of a debt that the creditor decides to permanently abandon; foreclosure or repossession resulting in debt cancellation; debt forgiven in a non-bankruptcy negotiation. The $600 threshold means smaller forgiven debts may not produce a 1099-C, but the income is still technically taxable.

Tax treatment. COD income is added to your taxable income for the year. At a 22% marginal tax bracket, $5,000 of COD income costs you $1,100 in federal tax. Plus state income tax in states that conform to federal rules.

The insolvency exception. Under IRC section 108(a)(1)(B), forgiven debt is not taxable to the extent you were insolvent at the moment of forgiveness. Insolvent means total liabilities exceeded total assets immediately before the forgiveness.

How to claim insolvency. File IRS Form 982 with your tax return. The form reports the amount of debt excluded under the insolvency exception. Attach a statement showing how you calculated insolvency.

Other exceptions. Bankruptcy: debt discharged in Chapter 7 or 13 is excluded regardless of solvency. Qualified principal residence debt: mortgage forgiveness on primary residence has special exclusion rules. Most consumer credit card forgiveness does not qualify for these other exceptions.

What to do if you receive a 1099-C. Verify the information is correct. Calculate whether you qualify for the insolvency exception. Prepare Form 982 if claiming exclusion. Include the COD income on your tax return. Keep all documentation for at least 3 years.

If you disagree with the 1099-C. If the creditor reported cancellation that did not actually happen, dispute it with the creditor. They can issue a corrected 1099-C. If the creditor refuses, file with the IRS explaining why the 1099-C is incorrect.

The phantom income problem. COD income is sometimes called phantom income because you do not receive cash; you just have your debt reduced. You owe tax on income you did not receive. This can be a hardship for taxpayers who settled debt because they could not afford the full amount.