[The links below were originally to 2010 IRS publication and forms. They now go to 2011 versions of the same pbulciation and forms. So, the page number references may be off and the quotes may be different. But the procedures should still be the same.]

This questions come up a lot. "I got a 1099C for a loan that was discharged in bankruptcy. What do I do now. Do I have to pay tax on the forgiven debt." You do not have to pay tax on debt discharged in BK. If you receive a 1099c on discharged debt, you will have to add one more form to attach to your tax return. If after reading this, you have any doubt about filing the return on your own, consult with a CPA. But, if you normally prepare your own returns, before you spend money to hire a CPA only because you received a 1099c, you may be able to get rid of any doubt by reading the IRS instructions. I'll even walk you through the pertinent parts.

The following only applies to those who received a 1099c for debt discharged in BK. If you received a 1099C for debt that was forgiven before you filed BK or not discharged in your BK and forgiven later, you still may not owe tax on the forgiven debt. Read publication 4681 to determine how to deal with the 1099c based on your circumstances. The process may be very similar.

Keep in mind that if a debt is secured and the lender forecloses, the foreclosure sale could result in a taxable gain to the debtor. This is a separate issue from whether a canceled debt is taxable as ordinary income and is not covered below.

So, to figure out what to do with this 1099C, let's start with your tax return, Form 1040. Instruction for 1040 are at http://www.irs.gov/pub/irs-pdf/i1040gi.pdf. On page 10, it says to see publication 4681 to determine where to report canceled debt from the 1099c. The following is from the introduction to the canceled debts section of Publication 4681:
There are several exceptions and exclusions that may result in part or all of a canceled debt being nontaxable. See Exceptions and Exclusions, later. You must report any taxable cancelled debt as ordinary income on:

* Form 1040 or Form 1040NR, line 21, if the debt is a nonbusiness debt;
* Schedule C (Form 1040), line 6 (or Schedule C-EZ (Form 1040), line 1), if the debt is related to a nonfarm sole proprietorship;
* Schedule E (Form 1040), line 3, if the debt is related to nonfarm rental of real property;
* Form 4835, line 6, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or
* Schedule F (Form 1040), line 10, if the debt is farm debt and you are a farmer.

Form 1099-C. If an applicable financial entity cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2. Unless you meet one of the exceptions or exclusions discussed later, this canceled debt is ordinary income and must be reported on the appropriate form shown above.
[For purposes of this explanation, I'm just going to assume we're dealing with nonbusiness debt]

So, taxable canceled debt is reported on line 21 of form 1040. But, if there is an exception or exclusion, the canceled debt is not taxable and therefore does not get entered on line 21.

Under exclusions, Pub 4681 says:

If a canceled debt is excluded from your income, that means it is nontaxable.
Just below that, under bankruptcy, it says:

How to report the bankruptcy exclusion. To show that your debt was canceled in a bankruptcy case and is excluded from income, attach Form 982 to your federal income tax return and check the box on line 1a. Lines 1b through 1f do not apply to a cancellation that occurs in a title 11 bankruptcy case. Enter the total amount of debt canceled in your title 11 bankruptcy case on line 2. You must also reduce your tax attributes in Part II of Form 982 as explained under Reduction of Tax Attributes, later.
[I believe the reduction of tax attributes has to do with basis in assets that forgiven debt is related to. If you think that applies to you, click on the link in the publication and read the instructions for form 982 so you can figure out how to complete part II of the form. In fact, even if you don't think it applies to you, read the instructs to make sure it doesn't.]

If the amount on line 2 of form 982 is equal to the amount of forgiven debt on the 1099C, there is no taxable income to report on line 21 of form 1040.

A note about Turbotax: If you use Turbotax to file your tax return, and you tell it you received a 1099c, it will tell you you can't use Turbotax to file the return. While you may not be able to use Turbotax to file electronically, you can use still it to prepare your return for filing by mail. Just, don't tell Turbotax you received the 1099c, print your return, download form 982 from the IRS website, fill it out and attach it to your return before mailing it. If you have another 1099c that does include taxable income, just enter it under other income without telling Turbotax it is from a 1099c.

I hope this helps people understand how to deal with a 1099c without having to go to the expenses of using a CPA. But, please understand that I am not a CPA. I believe people should be able to file their own tax returns without hiring a CPA if that is what they prefer to do. I have never received a 1099c. I've just seen the question asked so many times, that I decided to do the research to help others. If after reading the IRS instructions and publications, you are not confident you can correctly prepare your own return, please do consult with a CPA.