• Does the IRS Consider Cancellation of Debt Taxable Income?

    A friend once told me, “Don’t try to understand the tax code, just accept it”.  Yes, I will never understand the Internal Revenue Code in its entirety, but I do try to understand the general theory underlying the ruling. Cancellation of debt as income is one of those topics.

    Assume someone or some institution forgives the monies that you owe them.  While you may be relieved of the burden to pay back the loan, you didn’t receive any cash.  In fact that is probably the reason your debt was forgiven – your financial situation is not the best!

    When you borrowed the money from the bank, did the IRS tax that loan?  No, because borrowed funds are not considered taxable income.  But, if the bank forgives any part of that debt, the amount forgiven is now income and the financial institution will issue a 1099-C at the end of the year.

    During this economic crisis, many Americans have had credit card debt cancelled due to their inability to pay.  The example above reflects such a situation.  However, as one would expect, there are multiple exceptions to this rule.  Besides credit card debt homeowners have found it difficult to pay their mortgages.  To help ease the income reporting burden, Congress passed a few years ago the Mortgage Forgiveness Debt Relief Act of 2007.  This act allows up to $2 million of mortgage forgiveness debt to be excluded from income if the debt is forgiven in 2007 through 2012.  The debt must be acquisition debt and specific rules apply.

    As you can see there is a general rule and then there are the many exceptions.  If you receive a 1099- C, have had any cancellation of debt income, and/or face any other tax issue, please contact Lesemann CPA, PLLC.  We would be happy to answer any questions or discuss your specific circumstance.