If you owe creditors more than you can afford to repay, you may qualify to have the debt forgiven. But it’s important to know that while debt forgiveness cancels the debt you owe to your creditors, it may create or add to a tax debt to the IRS. Even if you’ve had debt cancelled, you may owe taxes on the forgiven debt.
Do You Owe Tax on Forgiven Debt?
The IRS treats forgiven or cancelled debt as income, which means it must be reported as income on your tax return, and it could increase the amount of tax you owe the IRS.
As with any income, if you do not report forgiven debt to the IRS or if you fail to pay the income tax you owe, you could end up owing more over time. The IRS will add penalties and interest for the unpaid taxes, and if you aren’t careful, you could end up with just as much debt as you had forgiven.
How to Resolve Questions about Taxes on Forgiven Debt
Make sure you work with a knowledgeable tax relief specialist, such as Tax Resolution Group, to ensure you get your questions answered. Tax Resolution Group helps people resolve tax issues and find relief by catching up on unfiled tax returns and settling tax debt – often for far less than what they actually owe the IRS. If you owe the IRS more than you can afford to pay, contact us for a free consultation.
There are some circumstances in which you may get an exemption for forgiven taxes and won’t owe taxes to the IRS. For instance:
- Debt discharge through bankruptcy – If you file for bankruptcy, your debt may be discharged by the court and not considered taxable.
- Insolvency – If you owe more debt than the total value of what you own, you may be considered financially insolvent. When you are insolvent, the IRS may be willing to exclude all or part of your forgiven debt from taxation. Work with a tax professional, such as Tax Resolution Group, to find out what tax reduction strategies you qualify for.
- Discharged student loans – When discharged or forgiven, student loans are usually exempt from taxation.
- Interest on debt – If the forgiven debt includes interest, the tax-deductible interest is not considered taxable income.
- Debt to friends or family – If you owe money to friends or family, they can offer you debt forgiveness in the form of a gift. Gifts up to a certain financial amount are not considered taxable income.
How to File a Tax Return with Forgiven Debt
If you have a debt forgiven of $600 or more, you may receive a 1099-C form. If the forgiven debt is tax exempt, you may need to file a Form 982 to report the amount that should be exempt, and the reason why the debt is tax exempt. When you have forgiven debt, cancelled debt, bankruptcy or insolvency, it’s important to share all of the information with your tax professional.
Tax Resolution Group can help with multiple strategies to reduce the amount of tax you owe and to resolve outstanding tax debt with the IRS.
What To Do If You Paid Tax on Exempt Income?
If you have a forgiven debt that should have been exempt from income tax, but you already reported the cancelled debt as income and paid taxes on it, don’t despair. You have three years to file an amended return and have than amount refunded to you or applied to other debt you owe the IRS. These complex situations are why you should work with a tax resolution professional.
Tax Resolution Group
Tax Resolution Group specializes in fixing tax problems. We offer tax services including tax resolution, tax planning, tax preparation and audit support. We offer in-person, socially distanced or virtual service, and we are ready to help you. Call us for tax help today at 941-413-2799 or Request a Free Consultation.