It may be possible for an individual to escape credit card debt by settling up with the bank or other issuer. While the debt is off the person’s back, it does not relieve the debtor of income taxes on the cancelled debt. Such relief is called cancellation of indebtedness (COD) income and it’s taxable. In one recent case (Glennon, TC Memo 2018-4), a taxpayer was duped into obtaining a credit card that was used for living expenses when he fell on hard times. He later settled with the bank to be relieved of the debt but didn’t report the COD income on his return, even though he received Form 1099-C, Cancellation of Debt. He just didn’t understand the concept of COD income.
The Tax Court was sympathetic to his plight but couldn’t rule in his favor. The treatment of COD income in this case is clear: it’s includible in gross income. It’s a matter of law that the court cannot change.
In another case, a taxpayer wanted the court to disregard her COD income in determining eligibility for the premium tax credit. She had purchased health insurance through the Marketplace using the advance premium tax credit to defray the cost of the premiums. The premium tax credit is a subsidy for taxpayers with household income below 400% of the federal poverty line. Household income is based on modified adjusted gross income. She reported the COD income on her return, which put her over the 400% limit. She didn’t file Form 8962 to reconcile the advance premium tax credit with what she was entitled to.
The Tax Court made it clear that household income means all income, including COD income, so she had to repay the credit (Michelle Keel, TC Memo 2018-5). The court recognized that sometimes a taxpayer’s income may wind up being more or less than what was estimated when the advance credit was determined. This must be resolved by filing Form 8962, Premium Tax Credit, with the income tax return for the year for which the advance credit was received. There is no basis on which to exclude this COD income from the definition of modified adjusted gross income, and consequently, household income.