1. Forgiven Debts which are Non-Taxable
There are forgiven debts which are exempt from 1099 reporting. One of these is debt canceled in a bankruptcy filed under Chapter
11. This is a form of bankruptcy involving a reorganization of a debtor’s business affairs and assets. Although it can be filed by
individuals, it is usually resorted to by corporations. Debts that are discharged in this bankruptcy are not taxable. It also takes
precedence over other exclusions. What’s more, no dollar limitations exist on the amount you can exclude under Chapter 11.
The Mortgage Forgiveness Debt Relief Act which was enacted in 2007 exempts income from the discharge of debt in your own
home. Debt that is forgiven because of foreclosure and mortgage restructuring are not taxable anymore. The coverage of this relief
applies to forgiven debts of up to $2 million from 2007 to 2012. Note that the Mortgage Forgiveness Debt Relief Act applies only to
debt or refinance debt used for the purchase, construction, or improvement of your principal residence. It does not apply to all
forgiven or cancelled debts that were not originally intended for either of these purposes.
Insolvency is another exclusion of forgiven debts that are deemed non-taxable. Theoretically, it is easy to calculate insolvency, or in
layman’s terms, the state of being broke. Before the discharge, you only need to calculate your total liabilities as well as the fair
market value of all your assets during that time. However, this is easier said than done since most consumers do not list down their
assets and liabilities. The exclusion only applies to the amount by which you were insolvent.
To be able to determine if you are insolvent, you will have to put a fair market value of all things you own—from jewelry to clothing to
appliances to virtually everything else in your possession. Then you add up all your outstanding obligations, including childcare and
utilities which have long been overdue. Subtract the liabilities from the assets and if the answer is in the negative (less than zero)
then that would mean that you are insolvent and can thus qualify for this exclusion.
To illustrate insolvency, let’s say that you have $20,000 debt which got settled for $5,000. In the 1099-C, the income from this
cancelled debt is $15,000. Upon inventory, your total assets were valued at $30,000 while your liabilities just before the debt got
forgiven were pegged at $50,000. This means that your finances were already short by $20,000. The $15,000 income from the
forgiven debt would be reduced by the insolvency so you only not need to pay tax.
If you had been forgiven the debt you owed to friends and relatives then the debt is considered a gift and is therefore not taxable.
Generally, you can’t claim canceled debt from financial institutions or individuals you’ve had a strict business relationship with (e.g.
your boss) as a gift.
Student loans can also be forgiven if it contains a provision saying that your loan can be cancelled if you use the field in which you
studied in to give service. For example, if you obtained a loan to finish your studies as a doctor and then, based on the provisions of
the loan, practiced your profession in an underserved community, you don’t have to pay taxes on the student loan that has been
forgiven.
You may not also have to pay taxes for forgiven interest that would have been deductible. If you could have deducted the interest
had you paid the loan, you don’t have to pay tax on the debt due to interest. Also, if the canceled debt was taken because of
something that you needed to do for your farm, the forgiven amount is non-taxable. The same also goes for loans taken out in
relation to business real estate and were later forgiven because the value of the property had significantly depreciated.
Find more articles on debt management by visiting this site: www.consolidatedebtguide.org.
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