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Do you have to pay taxes when debts are discharged under bankruptcy?

Bankruptcy Lawyer Bryan W. Stone answers the question: “What are my alternatives to bankruptcy?”

 

Anyone with a job understands that if you get paid you must pay taxes on what you earn. The same thing goes for those who receive other material benefits, even if it isn’t a paycheck, some tax must be paid for the benefit you received. An example of a situation where tax can be owed despite no cash changing hands is when a loan is forgiven. If a credit card company decided to settle a $25,000 debt for $15,000, you would need to report the difference, $10,000, on your taxes. Not only would you need to report the $10,000, but you’d be required to pay tax on the value of the loan that was forgiven. This leads to a question about the debt discharged in a bankruptcy. Do you have to pay tax on that too?

 

Tax sign Charlotte Chapter 7 AttorneyWhy is forgiven debt taxable?

 

First, let’s start with why such a thing should be taxed in the first place. The justification for taxing forgiven debt is that this forgiveness provides a tangible benefit to the debtor. This benefit should thus be treated as income and should then appear on your tax return. When a creditor forgives debt, it is required to issue a 1099-C tax form to the borrower showing the amount of debt not paid. This requirement is triggered when the amount at issue exceeds $600. This then appears on the debtor’s taxes and can result in a surprise tax bill for those who may not have been expecting it.

 

What about debts discharged in bankruptcy?

 

Thankfully, Section 108 of the Internal Revenue Code says that bankruptcy cases are not subject to traditional taxes on forgiven debt. That means that value of the debt that was discharged will not be deemed gross income and that no taxes will need to be paid on any of the money that was discharged.

 

What if you receive a 1099-C form?

 

In some cases, people could receive a 1099-C form from the IRS re: the discharged debts. If that happens you need to fill out another form, Form 982, which explains that the debt was discharged in bankruptcy and is thus not taxable. This should clear up the issue and will help ensure that no unnecessary tax burden is created due to the bankruptcy.

 

Why bankruptcy is sometimes the best option

 

Though taxes aren’t a big consideration for those thinking about filing for bankruptcy, the issue deserves some attention. If your financial situation is already precarious, you likely can’t afford to fork over thousands or even tens of thousands of dollars in taxes for money forgiven by creditors. Given this, bankruptcy can begin to look like an attractive alternative when compared to other options, such as debt consolidation or debt negotiation. While these other paths may result in lower debt, it’s critical that you account for the tax burden associated with these reductions in debt, a burden that would not exist if you filed for bankruptcy. When money is in short supply, even something that sounds good, like debt consolidation or forgiveness, can end up being a real financial burden come tax time.

 

If you are contemplating bankruptcy in the Charlotte area, please call the skilled lawyers at Arnold & Smith, PLLC find additional resources here. As professionals who are experienced at handling all kinds of bankruptcy matters, our attorneys will provide you with legally sound advice for your particular situation.

 

About the Author

Kyle Frost Bankruptcy Lawyer Student loan attorneyKyle Frost joined Arnold & Smith, PLLC in 2013 where he focuses his practice on all aspects of civil litigation and bankruptcy, including: Chapter 7, Chapter 11, Chapter 13, home loan modifications and landlord-tenant issues.

Born and raised in upstate New York, Mr. Frost attended the University at Albany on a Presidential Scholarship, graduating magna cum laude with a double major in Political Science and Sociology.  He went on to attended Wake Forest University School of Law in Winston Salem, North Carolina.

Following college, Mr. Frost spent over a year teaching English in South Korea. He worked in a private school in Seoul developing curriculum, English programs, and educating both children and adults that were interested in learning a new language.

In his spare time, Mr. Frost enjoys homebrewing, fishing, and travelling.

 

 

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