Understand Whether Your Cancelled Debt is Taxable Income


Taxpayers need to calculate their liabilities and assets to determine if cancelled debt is taxable.

 

Trying to manage your debt can be intimidating.

One way a business can work to become solvent again is through the cancellation of debt, and taxpayers who go through this process need to understand how it works so they can make the most out of the opportunity. This is particularly useful for those who work in the oil and gas industries, as the struggling economy is forcing many in the field to renegotiate terms of existing debt.

 

The cancellation of debt is exactly like it sounds. A lender can forgive a business’s debt if it becomes clear the debtor will never be able to repay it. Where the process becomes less clear cut is in determining whether that forgiven debt is considered taxable income. A business can make this determination for only the given year that cancellation of debt is being calculated. In certain scenarios, the IRS will treat forgiven debt the same way as income because it gives the same economic benefit.

 

“Cancellation of debt is initiated by one of eight identifiable events.”

One of eight identifiable events outlined through IRS regulations initiates cancellation of debt. Some of these events are declaring bankruptcy, foreclosure election and several other situations, including if a lender issues a Form 1099-C to a taxpayer.

 

To determine whether cancellation of debt income is taxable, taxpayers must determine solvency. The amount by which the taxpayer is insolvent is defined as the excess of their liabilities over the fair market value of their assets immediately before the debt is discharged. The amount of income excluded cannot exceed the amount by which the taxpayer is insolvent.

 

To get an accurate estimate on the FMV of assets, businesses should seek out professional appraisals to learn the current value of their assets. It is critical taxpayers understand that the IRS will look at the  present-day value of their assets and not their worth at the time of the original purchase.

 

Navigating insolvency can be challenging, but those going through it should know they have options. LaPorte has an experienced staff of tax professionals and accountants who are available to help anyone currently facing the prospect of insolvency or the cancellation of debt.

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