What Is the Tax Implication of Canceled Debt?

When you borrow money from a lender, it is your liability or debt. When your lender forgives or cancels your debt, you may have to recognize it as your taxable income depending on the circumstances. The lender is generally required to issue you a Form 1099-C for the cancellation of debt and submit it to the IRS. 

You must report any canceled debt as ordinary income unless you are in bankruptcy or insolvent or the you are discharged for qualified principal residence indebtedness. You must fill out Form 982 to report the exclusion and the reduction of certain tax attributes. The form needs to be filed with your personal tax return in the year a canceled debt is excluded from your taxable income. A properly completed insolvency worksheet should also be included.

We have quite a few clients who reached out to us because they received a letter from the IRS. The IRS letter is assessing additional tax on them because they failed to report the canceled debt as taxable income on their tax return. We reviewed their income profile and were able to fill out the insolvency worksheet for them. We were able to amend their tax return and exclude the income so they are not subject to additional income tax. 

In essence, we can get this additional tax from 1099-C removed in most cases. 

Many questions we have been asked are:

• How much canceled debt can I exclude from my taxable income?

• What documents do I need to provide to the IRS to prove my insolvency?

• How can I determine if I am insolvent?

• How to fill out the form 982?

• Will there be any penalty if I fail to report the canceled debt?

• Do I have to go to tax court or is there an easier solution? 

If you have similar questions and need help with canceled debt, please feel free to contact us. Dimov Tax Associates are happy to assist you with this matter.