Beware the benevolent creditor. I got a call from a probate lawyer yesterday who had encountered a strange issue. Here’s the deal. Decedent dies in 2006. Estate goes through probate. Estate is aware of credit card debt in the amount of $20,000.00. Estate notifies credit card of probate proceedings. Credit card company does nothing. Estate is closed.
Then in January 2010, the estate receives a 1099-C from the credit card company. What is that? The 1099-C shows that the credit card company forgave the debt. What a relief, right? Wrong. The amount of the forgiveness is treated as income to the debtor. Why would the credit card company do this? The credit card company gets to treat the forgiven debt as a tax deduction.
This is a lesson to all lawyers who are currently negotiating debt modifications/forgiveness. Be absolutely certain that you advise your clients of the tax consequences of any debt forgiveness.