When you have made the tough decision to file for bankruptcy relief and the dust has settled, the absolute last thing you want to think about is preparing your tax return. However, in order to rebuild your credit after bankruptcy, it is really important to make smart financial decisions and to be consistently aware of traps. One debt-related subject that is often misunderstood is how debt forgiveness is treated when it comes to your taxes.
Debt forgiveness occurs when a debt is discharged, cancelled, or forgiven for less than the amount the debtor still owes. While “forgiven debt” may sound like an amazing and magical prospect, it really isn’t. The circumstances when debt forgiveness occurs generally involve a creditor foreclosing on a person’s property, or where a creditor can no longer collect the amount a person still owes.
The General Rule Treats Forgiven Debt as Income
When debt is forgiven, there are generally tax consequences. Specifically, IRS Tax Topic Number 431 states that “In general, 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”. In other words, debt forgiven by a creditor is taxable income that must be reported on your tax return.
Significantly, creditors will report this forgiven, cancelled, or discharged debt to the IRS on a Form 1099-C, which means that the IRS is aware of this debt income, which the taxpayer must accurately report.
Debt Discharged in Bankruptcy is Excluded from Gross Income
Debts cancelled through bankruptcy proceedings are treated differently that debt forgiven, cancelled, or discharged outside of bankruptcy. In essence, the IRS does not treat debt that is discharged through bankruptcy proceedings as taxable income. In fact, they are listed as “exclusions” from gross income. This is a big deal and makes it extremely advantageous to file for bankruptcy under certain circumstances, like the cancellation of significant debt like a mortgage. Further, the overall tax savings from the exclusion of cancelled debt can make a huge financial difference to people in need of debt relief.
Let Levitt & Slafkes, P.C. Work For You
Bankruptcy has definite financial advantages for people seeking relief. At Levitt & Slafkes, P.C., we have decades of practical experience in the areas of bankruptcy and debt relief. Our attorneys are smart, no-nonsense professionals who take pride in providing effective legal guidance. Let us help you get some debt relief. Contact Levitt & Slafkes, P.C., at (973) 323-2953, or reach us online to schedule a free consultation.
We are proudly designated as a debt relief agency by an Act of Congress. We have proudly assisted consumers in filing for Bankruptcy Relief for over 30 years.