Attorney David Stonehill
David N. Stonehill Co., LPA
119 East Court Street
Cincinnati, OH  45202-1203
1-877-477-1099

Many taxpayers don't realize that when they settle their debts with credit card companies or other creditors, the Internal Revenue Service may consider that money saved as income for federal income tax purposes.  You say . . . WHAT!?

Yes, this is known as cancellation of debt ("COD") income, a creature of the IRS tax code, our Congress's Book of Dreams. Sometimes it's referred to as "discharge of indebtedness" income.

My name is David Stonehill, and I've been practicing law for about 27 years.  I look for practical solutions to problems faced by individuals and small businesses.  In many situations, COD income can be avoided or postponed.

Let's look at a simple example. Say Johnny owes $25,000 to XYZ credit card company.  He's in trouble making payments.  His rich uncle gives him $15,000 to settle this debt.  XYZ credit card company agrees to accept this lump sum payment of $15,000 in full settlement of the account balance, and writes off the $10,000 balance.

Because the amount of debt cancelled is over $600, XYZ credit card company must prepare Form 1099-C "Cancellation of Debt," and file the original with the IRS.  The taxpayer copy is mailed to Johnny. 

Johnny may have to include this amount of cancelled debt as "Other Income" on his Form 1040--US Individual Income Tax Return.  Unless that amount can be excluded from income, Johnny's taxable income will increase by $10,000.  Assuming that Johnny has a marginal tax rate of 25%, he owes additional federal tax of $2,500.

Is this fair? Perhaps not, but this has been the law for years. Generally, the amount by which you benefit from cancellation of debt is included in your gross income, so says the IRS.

There are, however, exclusions such as personal bankruptcy.  If instead Johnny filed bankruptcy to wipe out his debts, the law makes a special exception to exclude COD income created by personal bankruptcy (subject to some constraints).

What if you don't want to file bankruptcy?  Well, there's another exclusion to the extent that the taxpayer is considered "insolvent."  Here's how this works:

COD income may be excluded to the extent that the total amount of debts exceed total assets, valued as of the time just before the debt is cancelled.  There are specific regulations regarding what the IRS considers to be assets (and how to value them) as well as what are recognized debts. 

Special problems may arise with jointly held property, certain kinds of debts such as student loans, business or farm debts, residential foreclosures and short sales, and multiple debts discharged over more than one taxable year. Also, property subject to depreciation can be a real tax trap for the individual taxpayer, even with bankruptcy. 

To take advantage of this insolvency exclusion, you need to prepare an acceptable personal net worth statement.  The IRS has issued a specific form 982 for that purpose. This form is confusing, but nevertheless needs to be filled out accurately and filed within certain time limitations. Many tax regulations are not adequately explained in the instructions for preparing form 982.

This is where I may be able to help with your Form 1099 situation and avoid additional federal tax liability.  Because every situation is unique, call me toll free:

1-877-477-1099

1-877-IRS-1099

I'd be happy to discuss your situation confidentially and without any obligation on your part to engage my services during or after your initial call. 

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