How Wiping Out Debt Can Affect Your Taxes
From The Wall Street Journal
In this still-sluggish economy, debts can pile up beyond one's ability to repay. The only good news is that lenders are sometimes willing to forgive debts owed by especially beleaguered folks. While this can help you survive financially, it can also trigger negative tax consequences—but maybe not.
When a lender forgives part or all of a debt, it results in so-called cancellation of debt (COD) income.
The general rule is that COD income counts as taxable income. For the year when COD income occurs, the lender is supposed to report the forgiven amount to the borrower, and to the Internal Revenue Service, too, on Form 1099-C (Cancellation of Debt).
But there are several exceptions to the general rule:
Bankruptcy. If the borrower is in Title 11 bankruptcy proceedings when the COD income occurs, the income is completely exempt from federal income taxation. Title 11 encompasses bankruptcy filings under Chapter 7 (so-called liquidations), Chapter 11 (so-called reorganizations) and Chapter 13 (so-called wage earner filings).
Insolvency.When the borrower is insolvent (with debts in excess of the fair market value of his or her assets) immediately before debt cancellation occurs, the resulting COD income is exempt from federal income taxation to the extent of that insolvency. However, when the debt cancellation effectively makes the borrower solvent, the COD income is taxable to the extent the borrower is made solvent.
To read the entire article from The Wall Street Journal:
http://online.wsj.com/article/SB10000872396390444320704577562893581125870.html?mod=WSJ_FamilyFinance_MoreHeadlines
John 8:12 — I am the light of the world; whoever follows me will never walk in darkness, but will have the light of life.
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