Each year during tax season I hear from former clients and others who are concerned about 1099s issued by creditors whose claims, usually mortgages, were discharged in bankruptcy during the preceding tax year. Not to worry! But neither should you ignore it.
In some circumstances "cancelled debt" counts as income and is taxable. This is NOT the case with respect to debt discharged in bankruptcy. Nevertheless, many banks feel the need to issue the 1099 in order to report the fact of the cancelled debt to the IRS for the bank's own tax-reporting purposes.
Although the discharged debtor is not liable to pay tax on the "forgiven" debt reflected on the 1099, it may need to be reported on the debtor's income tax return (Form 982) in order to alert the IRS of the status. Make sure your qualified tax preparer is aware of the issue and receives the 1099.
