Forgiven debt sometimes isn’t taxed as income

Dear Liz: I lost my job 18 months ago. I am 61 and have back pain that keeps me from standing more than 15 minutes or sitting more than two hours before I have to lie down, which limits my job prospects. I arranged a short sale of my home a year ago to avoid a foreclosure, and recently received a 1099-C form from the lender for $99,000 of forgiven debt. Please warn others about this!

Answer: Don’t panic just yet.

Normally when a lender cancels or forgives debt, you have to include the forgiven amount in your income for tax purposes, which can result in a whopping tax bill.

But the federal Mortgage Forgiveness Debt Relief Act of 2007 provides an exception for homeowners who lose a home to foreclosure, sell it for less than they owe in a short sale or have their debt reduced through a mortgage modification.

You still have to report the forgiven debt on IRS Form 982, but it’s typically not included in your income for federal tax purposes if:

* The home was your primary residence (second homes, vacation property and rentals don’t qualify).

* The forgiven debt was $2 million or less ($1 million for a married person filing separately).

* The debt was forgiven in calendar years 2007 through 2012.

For more information, visit the IRS’ website at https://tinyurl.com/5pe43f. Details can also be found in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

You’ll have to do a little research to see what you might owe under your state’s income tax laws, which could differ. California, for example, hasn’t updated its law to conform with the federal law for mortgage forgiveness occurring on or after Jan. 1, 2009, although there are several bills pending in the Legislature to do so.

If you’re in California, you might want to bookmark this Franchise Tax Board page at https://tinyurl.com /yhx89zw and check back before filing your taxes April 15 to see if you get any relief.

How canceling a card dings credit

Dear Liz: As a result of the implementation of the new credit card legislation, my card issuer for the first time is going to charge me an annual fee of $60, effective April 1. I am strongly considering canceling my credit card because I rarely use it. I have two other cards that I use on a regular basis. But I heard that canceling a credit card can hurt your credit score. Is this true? If so, how many points could I lose?

Answer: Yes, closing cards can hurt your credit score, but it’s impossible to predict in advance how much. Typically, the lower your scores and the fewer open card accounts you have, the more you should avoid closing accounts. You also don’t want to close accounts if you’re about to apply for a major loan, such as a mortgage or car loan.

Because you have high scores and two other open accounts, though, you may be able to close this card without a huge effect on your scores, particularly if it’s not your highest-limit card. (Credit scoring formulas are sensitive to the amount of your available credit you’re using; most of the negative impact of closing a card comes from the reduction of available credit.)

Which online score is right?

Dear Liz: I got my credit reports and scores from a website that said my credit score for one bureau was 699. Then I went to MyFico.com, which said my score for that bureau was 601. Which is right?

Answer: The MyFico score is likely to be closer to the score an actual lender would use.

Many sites promise to give or sell you credit scores, but these scores typically don’t use the FICO scoring formula that most lenders use. The scores you get from other sites can give you a general idea of how lenders may view your creditworthiness but often vary substantially from your actual FICO scores.

Questions for possible inclusion in Liz Pulliam Weston’s column may be sent to 12400 Ventura Blvd., No. 238, Studio City, CA 91604, or via “Contact Liz” at www.asklizweston.com. Distributed by No More Red Inc.