Many debtors who filed bankruptcy and received a discharge also receive a 1099 cancellation of debt from creditors whose debt they discharged in bankruptcy in the form of a 1099-C or 1099-A. This means whether it’s your American Express debt or your first mortgage that you discharged in bankruptcy, you could potentially receive a 1099 from each.
Logically, you want to know if this debt forgiveness is income and possibly even if they owe this tax on debt forgiven, why did they even file bankruptcy in the first place? The short answer to that question is no, the debt forgiven is not taxable income; however, I should point out that exclusion is contingent on whether the debtor actually received a discharge.
This means that if you filed bankruptcy and received a discharge, even though you might receive a 1099, you are almost certainly excluded from paying taxes on the forgiveness of income.
Regardless of whether the income is taxable to the debtor (and in almost all circumstances in which the debtor received a bankruptcy discharge that year, it is not), it can still be proper for the creditor to send the debtor a 1099. The debtor needs to then fill out the IRS Form 982, which gets the debtor out of paying taxes on the 1099 income due to insolvency.
The very first box of the form, 1a, gives the debtor an exclusion by virtue of a discharge of indebtedness in a title 11 case, which is the bankruptcy chapter. If the debtor has any questions how to complete the form 982, he/she should consult a qualified tax professional.
This is not to say that bankruptcy is the only reason for someone to fill out the form 982. If you did not file bankruptcy, you still might qualify as “insolvent” for the purposes of avoiding tax liability. Or perhaps you are solvent, but qualify for the Mortgage Forgiveness Debt Relief Act and Debt Cancellation. This act current extends through 2012 and forgives most debt associated with losses on a primary residence.
In other words, the person who short sold their home to avoid bankruptcy might qualify to avoiding taxable income under the Mortgage Forgiveness Debt Relief Act and Debt Cancellation, but the person who filed bankruptcy qualifies for insolvency automatically.