Ask the Expert: Canceled debt is taxable

In 1992, I fell behind on credit card debt due to ill health. The card issuer let me settle the debt for a lesser amount and canceled it. In 2005, a collection agency wrote me that I owed them the balance of the canceled debt. I wrote back that I didn't know what they were talking about. I didn't hear from them again. In 2007, the canceled debt was reported to the IRS and I paid taxes on it. Is this legal?

Yes. Canceled debts are usually taxable income to the borrower. What's unusual here is that the lender (or the collection agency that bought the loan) waited 15 years to report the forgiven debt to the Internal Revenue Service.

Lenders report forgiven debt to the IRS on form 1099-C, sending a copy to the borrower. That should have happened in 1992. Apparently, the lender didn't write off the debt -- and therefore didn't report it -- until 2007. By then, the clock had run out for the IRS to collect taxes on 1992 income; so you didn't have to pay the tax. (The IRS can only look back three years, or six if it suspects your income was underreported by more than 25 percent. In fraud cases, there's no statute of limitations, but that's clearly not your situation.)

Unfortunately, it's too late for you to file an amended 2007 tax return. What should you have done in 2007? Income reported on your tax return should always match what the IRS has been told, says Alan E. Weiner, partner emeritus at Holtz Rubenstein Reminick, a Melville accounting firm. If the IRS has been misinformed, subtract the incorrect amount on another line and add a note of explanation.

The bottom line A canceled debt generally is taxable income to the borrower in the year it's canceled.

Websites with more information bit.ly/swIYRt and 1.usa.gov/tnFP35