SETTLED DEBTS MUST BE INCLUDED IN YOUR INCOME TAXES . . .
If you settle a debt for less than you owe, the balance canceled or forgiven by the creditor must be included in your gross income on your tax return. The creditor will send you an IRS Form 1099-C for Cancellation of Debt, and you must report the cancelled debt as taxable income. In fact, you must report the taxable amount of a forgiven debt even if the creditor does not send you a 1099-C.
Credit cards, personal loans, foreclosures, short sales — any debt settled for less than the full balance — can create a huge tax liability.
It’s important to determine how settling a debt will affect your gross income. Settling a debt versus discharging a debt in bankruptcy often has the effect of simply exchanging a private creditor for the IRS, which has vastly more powerful collection powers.
. . . BUT DEBTS DISCHARGED IN BANKRUPTCY ARE NOT TAXABLE.
Outside of bankruptcy, any forgiveness of debt is your taxable income. But debts discharged in bankruptcy are not taxable. Discharged debts are tax-free.
The bankruptcy discharge is given special treatment in the tax code because Congress wanted bankruptcy debtors to get a fresh start on their finances. The bankruptcy discharge carve-out is contained in Internal Revenue Code Section 108.
Unlike settled debts, debts discharged in bankruptcy are non-taxable, so when it comes to taxes, filing a Chapter 7 bankruptcy or Chapter 13 bankruptcy will be almost always be preferable to debt settlement.
In some less common cases, discharged debts may reduce “tax attributes,” such as loss capital loss carry-forwards. In those cases, an IRS Form 982 should be filed. (For more information on this, see IRS Publication 4681). In general, though, those do not affect most of my clients. I always recommend consultation with an accountant in the tax year following your bankruptcy discharge.
WE HELP PEOPLE FILE FOR BANKRUPTCY.
Debts discharged in bankruptcy are not taxable. Debts you settle for less than what is owed are taxed. If you want to understand your different bankruptcy options, seek out the personalized legal advice of the bankruptcy attorneys at Lee Legal. We are a debt relief agency. We help people file for relief under the Bankruptcy Code. To schedule a free financial analysis, call (202) 448-5136.