How to Avoid Taxes on Cancelled Debt
A 1099-C is a tax form issued by a creditor, which states that their debt was cancelled last year. If you received this form, it is because the IRS takes the position that cancelled debt was actually income to you. Unless an exclusion applies, you will be required to pay taxes on that cancelled debt. IRS Form 982 provides several possible exclusions to these taxes.
First, there are no tax consequences for debts discharged as a result of bankruptcy. If you successfully obtained a discharge in a bankruptcy case, then Form 982 provides a clear exclusion from any subsequent taxes on those discharged debts.
Second, you can exclude tax on cancelled debt to the extent that you are insolvent. You are deemed to be insolvent if, as of the date of debt cancellation, the total amount of your debts exceeded the total value of your assets. In some cases, this calculation can be quite complicated.
Third, if the cancelled debt was a mortgage that you obtained in order to buy, build, or improve your home, then it may be excluded from taxes under the Mortgage Debt Relief Act of 2007. This exclusion has provided significant relief to individuals who lost their home to foreclosure, participated in a short sale, or were able to settle their account for less than the full balance. Unfortunately, the Act was only extended through the end of 2013 and has not yet been extended by Congress.
There are other potential exclusions available as well, each of which should be thoroughly reviewed with your tax preparer.
Regardless of whether you are able to exclude these taxes, though, if you have not filed for bankruptcy then a creditor might still attempt to collect a cancelled debt from you. The law in this area is still developing, and even though post-cancellation collection efforts would appear to be unfair and deceptive, a majority of courts have held that such collection efforts are allowed.
Therefore, if you are seeking to settle any debts for less than the full balance without filing for bankruptcy, then you would be well-advised to speak with a tax professional in order to determine whether there will be any tax consequences. If you would like to review your bankruptcy options in order to prevent incurring taxes on discharged debts, then please contact us today to discuss.
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Culik Law is a Massachusetts Attorney / Law Firm. The posts on Culik Law’s blog are not intended as legal advice. If you have questions about your particular situation, CONTACT CULIK LAW for a Free Consultation.