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.
Return to Home Page.
More information about my
services offered.
Important
terms of engagement and information about me.
Click here if you wish to email me.
Please be aware that email is not secure, so do
NOT include any sensitive or confidential information.
Disclaimer and Terms of Use.
Please read this important disclaimer about your
use of the information contained in this web site, and how you should act
upon matters involving your legal rights.
This is advertising materials.
This web site
is designed for general information only. The information presented should not
be construed to be formal legal advice, nor the formation of a lawyer/client
relationship.
The hiring of a lawyer is an important decision that should
not be based solely upon advertisements. Before you decide, ask me to send to
you free written information about my qualifications and experience. This web
site provides general information about my services. I do not intend it to
constitute, nor should the reader understand it to provide, legal
advice.
 |
Copyright © 2007
David N. Stonehill Co., LPA
All rights
reserved. |
|
