The irs sent us a letter saying we owe thousands on a car that was reposted several years ago, that the bank wrote it off and considers the debt income. Help?

[Anon6]

We got this letter claiming that the bank wrote off a car that was repossessed then resold by the bank. The letter says the irs considers this income since the bank wrote it off(?).

I’m not understanding why the bank taking and reselling the car then writing the rest off would result in us getting a letter saying we owe the full value of the car, especially since we don’t own or posses the car, and I’ve never heard of anyone having to pay the value of a repossessed car to the irs before. Is this legitimate? 

[Opus 17]

 Generally speaking, I’ve forgiven or canceled loan is taxable income to you, because you received money and did not pay taxes on it when you borrowed it. Since you don’t have to pay it back, that becomes taxable income to you.

However, the paperwork or may not be correct. I assume you received a 1099 – C form from the bank, or the IRS received a copy even if you didn’t.  Your first step is to get a copy of the 1099 – C form and see exactly what it says.  You may owe less than the IRS thinks.  

Were you in bankruptcy when the loan was canceled?

Be aware there are strict time deadlines for responding to an IRS letter. If you don’t respond by the deadline, then the IRS assumes you owe the full tax and you lose your right of appeal.

[Lisa995]

Whatever the bank sold the car for didn't pay off the debt you owed to the bank, so the bank canceled the remaining debt (rather than taking you to court and suing you for it) so remainder of the debt to the bank is considered income to you.  
Its always much cheaper to pay the tax on a canceled debt than it is to pay the debt itself.

If you were not in bankruptcy, you may want to read up on Insolvency and see if that applies to you, you may be able to reduce or eliminate the taxable amount of the canceled debt if you were insolvent at the time the debt was canceled.

[Opus 17 · Accepted solution]

Here's what is supposed to happen.

Suppose you borrow $20,000 to buy a car, and you stop making payments when you still owe $15,000.  The bank repossesses the car and sells it at auction for $8,000.  You owe a $7,000 deficiency, plus fees and interest.  The bank puts it in collection for a few years, then gives up and writes it off.  The written-off amount is $8,500 balance plus fees and interest.  

That amount is taxable income to you, because you borrowed it, didn't pay tax, and are now getting to keep the money and not pay it back.  The bank issues a 1099-C for the amount of the canceled debt.  The date on the 1099-C is the date of an "identifying event" that specifies when the debt was canceled.  The bank mails you the 1099-C and sends a copy to the IRS.  If you didn't get the 1099-C, maybe you moved and the bank didn't know your address.  You can get a transcript of it here (ask for a wage and income transcript) https://www.irs.gov/Individuals/Get-Transcript

The canceled debt is income in the tax year that it was canceled, and you will need to file an amended return to report the income and pay tax.

If the debt was canceled due to bankruptcy, it is not taxable, but you have to report it on your tax return and claim the exclusion for bankruptcy.  If you were insolvent when the debt was canceled (owed more total debts than you could reasonably pay back) you may also be able to exclude the income and pay no tax, but this requires a special worksheet that Turbotax does not support, you may want to see a professional. https://www.irs.gov/forms-pubs/about-publication-4681

If the bank issued the 1099-C for the wrong amount, you still owe tax but less than the IRS says.  Prepare an amended tax return listing the actual amount of canceled debt, and mail the amended return, a check for payment, and a letter of explanation, to the office that sent the notice.  Also include copies of your loan, letters from the bank, and other proof that the canceled debt was less than the bank reported on the 1099-C.

Amend https://ttlc.intuit.com/replies/3288565