The "Debt Monkey" Who Can Turn Into A "Tax Monkey" Right Before Your Very Eyes!

Not too long ago, loans seemed to be flowing like Niagara Falls. Now with the economy in a recession (or is it a depression?), the “credit party” has turned into awful “debt hangover” for millions of Americans.

With the Government bailing-out huge conglomerates, many individual taxpayers have the attitude of… “I’m in over my head. All these poorly-run, greedy companies are getting billions and no one is bailing ME out. I think I’ll walk away from these huge bills (or at least get it reduced to pennies on the dollar.)”

Well, “hold yer’ horses partner” before you go riding off into that debt-free sunset.

It’s important to realize that there may be tax implications when you are given “Debt-Forgiveness” or “Debt-reduction.”  

Basically, debt-forgiveness or reduction is when you or someone you hire convinces the loan company that you can’t pay the full amount of your debt; so they’re willing to settle for less. They know if you are forced into bankruptcy court, they may get nothing.

Here’s an example: let’s assume the lender forgives $30,000 of your debt. This amount may include money you actually received along with penalties, fees, and interest.  

Sounds great, right?

Well, the credit company can’t just “eat” this loss. So for them to “write off” all $30,000, they need to “charge” the same amount as income to someone. (When the IRS giveth to one, they taketh from another.) 

Guess who that someone is?

That’s right…YOU!

The IRS considers forgiveness of debt as taxable income to YOU. As a result of this “write off”, by law, the company forgiving the debt MUST send you a 1099-C (or Cancellation of Debt) form showing miscellaneous income of $30,000 in the year forgiven. You then must list this as other income on Line 21 of the 1040 tax form. Now with this additional income, you may owe significantly more taxes than expected!

If this all seems like your debt wasn’t really “forgiven” but just transferred to the IRS, you’re partially correct.

There’s good news and bad news!

The good news is that the total you now owe (remaining debt plus taxes due) IS less than your previous debt, but the bad news is you may now owe one of the toughest bill collectors known to mankind…the Internal Revenue Service.

So if you have received or plan to receive some type of loan forgiveness or reduction, be aware that this form is coming, and be prepared for the additional tax burden. If you need help understanding the tax implications of loan forgiveness, please contact your local PRO-TAX office today or call us at 1-800-809-2829.

Now before you start screaming this is “not fair”; you’re right and Congress realized they need to “level the playing field” for some taxpayers. To help they created some tax exclusions where the forgiven debt will NOT be considered taxable income.

Bankruptcy

The exclusions include debts discharged during bankruptcy and debts of consumers who are insolvent (meaning their liabilities exceed their assets) prior to the cancellation of debt. However, the exclusion applies only up to the amount by which consumers are insolvent. That means if $5,000 in debts were forgiven and liabilities exceeded assets by $2,000; then the $2,000 would be excluded as income. The remaining $3,000 would be reported as “other income.”

Mortgage Forgiveness

Homeowners who default on mortgage loans may also qualify for exclusion of their foreclosures under the Mortgage Forgiveness Debt Relief Act, which took effect Dec. 20, 2007, to help homeowners caught in the mortgage crisis.

Other Exclusions

Other exclusions may include certain farm debt, student loans and real property business debts. Contact your local PRO-TAX office or call us at 1-800-809-2829, to see if you qualify for any exclusions.

Taxpayers may qualify for one of several exclusions that allow them to reduce taxable income from canceled debts. If the exclusions apply, they must file an IRS Form 982 in addition to the 1099-C. PRO-TAX will be happy to assist you with any of these forms.

Debt Forgiveness can give you a little breathing room to get your finances back in order, but don’t let an unexpected tax bill catch you off guard. Call PRO-TAX today at 1-800-809-2829 if you have any questions or would like to see how debt forgiveness may affect your tax bill.

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