Taxation of forgiven debt

Many people go through serious financial problems at some stage of their life and hence start missing their payments on credit card bills. The account may be sent to some collection agency after the account has gone delinquent for quite some time and hence they will be willing to settle for less than half of the total balance. Once the account is paid off, the debtors often think that the matter is closed, but it is not like that. The creditor will issue a 1099-C. It is actually a notice to the IRS about the forgiven debt. The debtor has to pay taxes on the amount forgiven as it is shown as an income. And if he does not it during the time of his filing taxes, then heavy penalties and fines will get imposed.

Sometimes, your home may also get foreclosed by the mortgage lender if the property is sold for less than the amount of the loan. In this case, the borrower not only loses his home but also have to pay huge tax bills. This bill will come after many months after the tax was filed as a result of an IRS document matching program. This “under-reporter” notice brings grief to the taxpayer.

The only way by which the debtor can escape from this situation if he is not filing taxes on the forgiven debt is to prove insolvency. There are certain circumstances by which he can qualify in an “Insolvency exclusion”. You are considered to be insolvent when your liabilities exceed the fair market value of your assets. In that situation, the forgiven debt will not be considered taxable or only a portion of it is counted as income.

You may not have any taxable income from the 1099-C, but you must show it on your return. You have to prove whether you were insolvent at that time when the debt was canceled. You owe taxes on the amount forgiven. For example, if the forgiven debt is $10,000 and your financial situation is worth $5000, you would only have to pay taxes on the amount left. Home foreclosures is quite complicated and you may have other legal arguments besides insolvency.