Generally, debt that
is forgiven or canceled by a lender is considered taxable income by the IRS and
must be included as income on your tax return. Examples include a debt for
which you are personally liable such as mortgage debt, credit card debt, and in
some instances, student loan debt.
When
that debt is forgiven, negotiated down (when you pay less than you owe), or
canceled you will receive Form 1099-C, Cancellation of Debt, from your
financial institution or credit union. Form 1099-C shows the amount of canceled
or forgiven debt that was reported to the Schaumburg IRS
Audit. If you and another person were jointly and severally
liable for a canceled debt, each of you may get a Form 1099-C showing the
entire amount of the canceled debt. Give the office a call if you have any
questions regarding joint liability of canceled debt.
Creditors who
forgive $600 or more of debt are required to issue this form. If you receive a
Form 1099-C and the information is incorrect, contact the lender to make
corrections.
If you receive a
Form 1099-C, don't ignore it. You may not have to report that entire amount
shown on Form 1099-C as income. The amount, if any, you must report depends on
all the facts and circumstances. Generally, however, unless you meet one of the
exceptions or exclusions discussed below, you must report any taxable canceled
debt reported on Form 1099-C as ordinary income on:
- Form 1040 or Form 1040NR, if the debt is a non business debt;
- Schedule C or Schedule C-EZ (Form 1040), if the debt is related to a nonfarm sole proprietorship;
- Schedule E (Form 1040), if the debt is related to non-farm rental of real property;
- Form 4835, 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), if the debt is farm debt and you are a farmer.
Exceptions and Exclusions
If you had debt
forgiven or canceled last year and receive a Form 1099-C, you might qualify for
an exception or exclusion. If your canceled debt meets the requirements for an
exception or exclusion, then you don't need to report your canceled debt on
your tax return. Under the federal tax code, there are five exceptions and four
exclusions. Here are the five most commonly used:
Note: The
Mortgage Debt Relief Act of 2007, which applied to debt forgiven in calendar
years 2007 through 2014, allowed taxpayers to exclude income from the discharge
of debt on their principal residence. The PATH (Protecting Americans from Tax
Hikes) Act extended this relief through the end of 2016.
Up to $2 million of
forgiven debt was eligible for this exclusion ($1 million if married filing
separately) and debt reduced through mortgage restructuring, as well as
mortgage debt forgiven in connection with a foreclosure, also qualified for the
relief.
1. Amounts
specifically excluded from income by law such as gifts, bequests, devises or
inheritances
In most cases, you
do not have income from canceled debt if the debt is canceled as a gift,
bequest, devise, or inheritance. For example, if an acquaintance or family
member loaned you money (and for whom you signed a promissory note) died and
relieved you of the obligation to pay back the loan in his or her will, this
exception would apply.
2. Cancellation
of certain qualified student loans
Certain student
loans provide that all or part of the debt incurred to attend a qualified
educational institution will be canceled if the person who received the loan
works for a certain period of time in certain professions for any of a broad
class of employers. If your student loan is canceled as the result of this type
of provision, the cancellation of this debt is not included in your gross
income.
3. Canceled debt,
that if it were paid by a cash basis taxpayer, would be deductible
If you use the cash
method of accounting, then you do not realize income from the cancellation of
debt if the payment of the debt would have been a deductible expense.
For example, in
2015, you obtain accounting services for your farm using credit. In 2016, due
to financial troubles you were not able to pay off your farm debts and your
accountant forgives a portion of the amount you owe for her services. If you
use the cash method of accounting you do not include the canceled debt as
income on your tax return because payment of the debt would have been
deductible as a business expense.
4. Debt canceled
in a Title 11 bankruptcy case
Debt canceled in a
Title 11 bankruptcy case is not included in your income.
5. Debt canceled
during insolvency
Do not include a
canceled debt as income if you were insolvent immediately before the
cancellation. In the eyes of the IRS, you would be considered insolvent if the
total of all of your liabilities was more than the FMV of all of your assets
immediately before the cancellation.
For purposes of
determining insolvency, assets include the value of everything you own
(including assets that serve as collateral for debt and exempt assets which are
beyond the reach of your creditors under the law, such as your interest in a
pension plan and the value of your retirement account).
Here's an example.
Let's say you owe $25,000 in credit card debt, which you are able to negotiate
down to $5,000. You have no other debts and your assets are worth $15,000. Your
canceled debt is $20,000. Your insolvency amount is $10,000. Because you are
insolvent at the time of the cancellation, you are only required to report the
$10,000 on your tax return.
If you exclude
canceled debt from income under one of the exclusions listed above, you must
reduce certain tax attributes (certain credits, losses, basis of assets, etc.),
within limits, by the amount excluded. If this is the case, then you must file
Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and
Section 1082 Basis Adjustment), to report the amount qualifying for
exclusion and any corresponding reduction of those tax attributes.
Exceptions do not
require you to reduce your tax attributes.
Questions?
Don't hesitate to
call if you have any questions about whether you qualify for debt cancellation
relief.
Www.SchaumburgCPA.Info is an
official blog of Manen Kothari CPA. To ensure compliance with the requirements
imposed by the IRS, we inform you that any U.S. federal tax advice contained in
this communication (including any attachments) is not intended or written to be
used, and cannot be used, for the purpose of (i) avoiding penalties under the
Internal Revenue Code or (ii) promoting, marketing, or recommending to another
party any transaction or matter addressed herein. One should consult their tax
advisor before any of the information contained herewith applied to their
individual tax situations. SK Tax Associates, Schaumburgcpa.info, or Manen
Kothari cannot be held responsible for any general information stated above.
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