Bankruptcy, Debt Relief, And Taxation: What You Should Know
If you are seeking a debt settlement or a non-bankruptcy workout, or if you are planning to file for bankruptcy, you may be unsure about how taxation of any debt relief or discharged debt or forgiven debt will be handled. Our West Palm Beach bankruptcy lawyers know that questions about debt relief and taxation can be complicated, and we want to provide you with more information that can help you to determine whether you want to seek a non-bankruptcy workout or personal bankruptcy, and how any forgiven debt or discharged debt will be handled at tax time. In short, debts that are forgiven are taxed, but discharged debts are not taxed. Consider the following information.
Forgiven Debt and Taxes
If you have debt forgiven by a creditor, which is also known as having debt canceled, any amount of debt that is forgiven or canceled will be treated by the Internal Revenue Service (IRS) as taxable income. There are exceptions—including for bankruptcy discharges, which we will explain below—but in general, you should assume that you will need to pay taxes on forgiven debt.
The IRS provides more information: “If you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.” Anytime debt is canceled or forgiven, the debtor will typically receive a Form 1099-C, “Cancellation of Debt” form. That form will cite the amount of debt forgiven, which the debtor will need to include in their income taxes for that tax year.
Bankruptcy and Discharged Debt
If you have debt discharged through a bankruptcy case, you will not have to pay taxes on the amount of the debt that has been discharged because of a bankruptcy exclusion. Why is this the case if canceled debt is considered to be taxable income by the IRS? As an article in The Balance explains, debts that are discharged through a bankruptcy case are not considered to be income.
You might still receive a Form 1099-C from one or more of your former creditors, but receiving this form does not mean that you will need to pay income taxes on this amount of money. According to the article and tax details from the IRS, debtors should attach Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness,” to report the bankruptcy exclusion. It is important to know, however, that the bankruptcy exclusion will not apply to any debts that were forgiven by a creditor before you filed for bankruptcy. Accordingly, if you plan to file for bankruptcy, you will not likely want to enter into a debt settlement with a creditor to have any amount of debt forgiven since you will need to pay tax on that amount.
Learn More from a West Palm Beach Bankruptcy Lawyer
The ways in which debts are considered to be canceled, discharged, and forgiven can be extremely confusing, and the circumstances in which these debts are taxable or subject to an exclusion can be very complicated. Whenever you have questions, you should seek advice from one of the experienced West Palm Beach bankruptcy lawyers at Kelley Kaplan & Eller.
Sources:
irs.gov/taxtopics/tc431
thebalance.com/canceled-debts-are-not-taxable-income-in-bankruptcy-3973987#citation-6
irs.gov/pub/irs-pdf/p4681.pdf
