Cancellation of Debt and Your Income Tax Return
Author: Frank Addessi
The old saying there is no such this as Free Money still holds true, especially when it comes to the IRS and debt forgiveness. Many people get in over their heads with credit card and other debt and sometimes after years of trying creditors forgive the debt and take the tax deduction that comes along with the loss but one company's loss may be your taxable gain.
As a general rule if a creditor cancels your debt to them it will be considered income to you by the IRS. So, if at the end of the year you receive a Form 1099-C, Cancellation of Debt for an old credit card let's say your joy should be short-lived because your gross income just went up by the amount forgiven and it's fully taxable unless the creditor is still actively trying to collect the debt from you.
A debt includes the full amount you owe up to the value of any property securing the debt. This means, using a car loan as an example; if you owe $20,000 and the car is repossessed and is only worth $10,000 and if that debt is forgiven then you have $10,000 in additional taxable income. You must report the difference as ordinary income on your tax return. Furthermore according to IRS Publication 4681 in the case of repossession you must report the income even if you do not get a 1099-C.
As with all thing there are exceptions and in this case the IRS has several Exceptions and Exclusions and they are:
Canceled Debt that Qualifies for EXCEPTION to Inclusion in Gross Income:
- Amounts specifically excluded from income by law such as gifts or bequests
- Cancellation of certain qualified student loans
- Canceled debt that if paid by a cash basis taxpayer is otherwise deductible
- A qualified purchase price reduction given by a seller
Canceled Debt that Qualifies for EXCLUSION from Gross Income:
- Cancellation of qualified principal residence indebtedness
- Debt canceled in a Title 11 bankruptcy case
- Debt canceled during insolvency
- Cancellation of qualified farm indebtedness
- Cancellation of qualified real property business indebtedness
There are separate rules for "qualified principal residence indebtedness" your primary residence. This rule provides some relief for people whose home was involved in the mortgage foreclosure crisis that has affected so many homeowners. The exclusion allows you to exclude up to two million dollars (one million dollars if married filing separately) for a "qualified principal residence.
In the event you can exclude your cancelled debt from income based on one of the exclusions discussed earlier you must also reduce your tax attributes (a kind of loss) by the amount you excluded. The IRS requires that you file a Form 982, "Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)"
When it comes to debt cancellation and your tax return I recommend that you consult a qualified CPA to protect yourself from a bigger tax and debt nightmare. At the very least I suggest that you read IRS Publication 4681, "Canceled Debts, Foreclosures, Repossessions and Abandonments (for Individuals).
Article Source: http://www.articlesbase.com/taxes-articles/cancellation-of-debt-and-your-income-tax-return-6096917.html
About the AuthorI have been writing about taxes, tax prearation and accounting related topics for 10 years. As the manager of CPA Tax Center a full service CPA firm specializing accounting, bookkeeping and income tax preparation services for individuals and businesses. We also offer online tax preparation.
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