del.icio.us
Digg
Sphere
Stumble
Technorati
Twitter
Dealing With Forgiven Debt
By Susan Berson
Bankruptcies, foreclosures, and creditors writing off debts: these consequences of the recession are well-known. The potential year-end tax hit, however, may come as a surprise. But the fact is that if you’ve had a creditor write off a car loan, credit card debt, medical bills, or another sort of personal loan, there is a good chance that the Internal Revenue Code may require you to treat the amount forgiven as income.
Amount of Debt Forgiven is Taxable, With Exceptions
The general rule is that when a creditor writes off a debt, the amount of the cancelled debt is treated as taxable income to the debtor. Procedurally, the creditor issues a Form 1099-C, Cancellation of Debt, to the debtor. There are exceptions: prominently, homeowners who have had their mortgage debts cancelled when their homes were foreclosed upon and sold do not have the forgiven debt counted as income. However, many are unaware that such homeowners, along with others who may qualify for an exception, still must make a filing--a Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)--to take advantage of the exception.
Overall, according to IRS data, it is likely that an estimated two million taxpayers will receive a Form 1099-C. Unfortunately, the IRS estimates that hundreds of thousands of these taxpayers who would otherwise qualify to claim an exception and exclude the cancelled debt(s) from gross income will fail to file the Form 982--paying more tax than required by law because they unnecessarily will include the amount of the cancelled debt in their gross income. On top of that, they risk prompting an audit.
Tips for Preparing and Filing the Form 982
The amount reported by the creditor to the IRS as being cancelled will be listed in box 2 of the Form 1099-C, Cancellation of Debt. (You should receive this Form 1099-C from your creditor by mid-February 2010.) To determine the amount of the cancelled debt that must be included or excluded from your income, consult Publication 4681, which details the instances when cancelled debt can be excluded from income. Calculating the amount that qualifies for exclusion may be as simple as recording box 2 of the Form 1099-C, for lines 1e, 2 (and possibly 10b) of the Form 982. Then, attach the Form 982 to the completed Form 1040. Most business taxpayers, however, should be prepared for the form to take several hours to complete because of the complex nature attributable loss and/or basis calculations.
Susan Berson, a partner at the Banking & Tax Law Group LLP, is the author of The Modern Rules of Personal Finance for Professionals, and other books.
Comments (0)November 10, 2009 9:56 AM
