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Settling Up Old Debts
Loss wages affects not only immediate debt, but also long-term debt. In accounting terms, these would be considered current liabilities and non-current liabilities. This isn’t an accounting lesson, so I digress. What we have seen in recent years are record numbers of foreclosures, short sales, credit card debt settlements, abandoned properties, and repossessions. Serious stuff. However, what I want to focus on is the taxability from such settlements or decisions.
Generally, if a debt for which one is personally liable for is canceled or forgiven, that person must include the canceled debt as income for taxes. This includes loan modifications (workout), discounts, debt settlements, and other arrangements where the lender accepts less than the outstanding debt as full payment. The personal liability of the debt is determined by a person signing for the debt; this also includes co-signers. If you sign it, you are responsible. If the debt that was canceled is greater than $600, the lender is required to issue the debtor a Form 1099-C “Cancellation of Debt”. This income is included in the year that the debt was canceled.
Form 1099-C is overlooked in many cases by taxpayers. It’s unfamiliar and most people don’t know what to do with it. It’s easily forgotten about when taxpayers submit their documents to their tax preparer. The worst scenario is if the taxpayer prepares his or her own tax return and the tax software never asks the question, “Did you have any canceled debt this year?” A little hint, the tax software won’t ask the question because it’s not a common form. So the return is prepared, submitted, and a year later you receive an IRS correspondence stating adjustments made to your tax return due to omission of income. It’s frightening to say the least but there are options.
There are several exceptions in which canceled debt may be excluded from income. The most common exceptions are when debt is canceled in a title 11 bankruptcy case, when the taxpayer is insolvent to the extent of the canceled debt, and debt of a qualified principal residence. In either three cases, the amount excluded from income needs to be reported to the IRS on the taxpayer’s tax return. Additional forms must be filed along with Form 1040.
So, those of you that may be a part of a debt settlement program, settled debt on your own, received a loan modification, or maybe had your home foreclosed, it may not be over just yet. I suggest you seek a tax professional to assist you in this matter.
Antonio Brown, CPA, MBA is a contributor to healthyblackmen.org. He is President of AC Brown, CPA & Associates, PLLC in Flint, Michigan.