Tip of the Day for 12/3/2012: “Income Tax on Forgiveness of Debt”

Tip of the Day for 12/3/2012: “Income Tax on Forgiveness of Debt”

Bankruptcy Tip of the Day for December 3, 2012: “Income Tax on Forgiveness of Debt”

If you settle a debt with a creditor for less than the balance owed, the creditor will most likely send you an IRS 1099C form at the end of the year reporting that the creditor forgave or “discharged” debt. Most people assume they owe income tax on this amount. In fact, if you don’t list the “income” reported on the 1099 as income on your tax return, the IRS will probably add it for you and send you a bill for tax on the unreported income plus penalties. What many people don’t know, including many tax return preparers, is that there is another IRS form you can file with your tax return to counter the 1099 you got from the creditor. It is IRS form 982. There are three major exceptions to the rule requiring you to pay income tax on forgiven or discharged debt. These three exceptions can be claimed on form 982 with the result that you will not owe tax on the amount of debt which was forgiven. The three exceptions are: (1) that the debt was discharged in bankruptcy; (2) that the debt was forgiven in connection with money owed on a mortgage secured by your personal residence; and (3) that you were “insolvent” at the time the debt was forgiven. For purposes of form 982, you are considered insolvent if your total debts are more than your total assets. You may qualify for one of these exceptions and you will not have to pay tax on the amount of the forgiven debt, but you have to file form 982. I have to include a disclaimer here. I am not a tax expert and this information is just given here to raise the issue so my readers are aware of the possibility of countering the 1099C. There are more details, rules and technicalities involved in the issue of taxability of forgiven debt, so you will have to be careful and consult with someone who is knowledgeable about the rules and familiar with your particular situation.

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Justin A. Steele

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