Canceled Debt Bankruptcy

Due to the current financial disaster in the United States, many individuals have gotten behind on their mortgage obligations. A handful of reasons have caused this horrific situation: loss of employment, result of underemployment, companies downsizing, or adjustable mortgage rates taking effect causing the borrower to fall behind. Because of all of these factors, individuals find themselves in able to pay their lenders. The result can be foreclosure, repossession, abandonment or even bankruptcy.

As a Denver bankruptcy attorney, I see this situation everyday. Sometimes a personal bankruptcy is warranted; other times, an alternative solution might be possible. As an attorney, it is my job to present the different options to my client and allow him/her to elect that which he/she wants to do. It can be difficult, at times, to see the stress, heartache and worry that these individuals are experiencing. Often times, I feel more like an counselor rather than a lawyer.

Canceled Debt Circumstances

A debtor approaches a bankruptcy with the understanding or hope that he/she will be able to attain a "fresh start" financially. That is the real purpose of a bankruptcy- to allow the debtor to get back up on his/her feet again. Goodness knows that creditors will knock him/her down every chance they have. Whether you are a single mother with children or a young adult trying to begin life, if you default on a financial obligation the creditor will hunt you down and use any legal means necessary to collect the owed debt. Therefore, many individuals have no other option than to file for bankruptcy.

Whether a Chapter 7 bankruptcy or Chapter 13 bankruptcy is filed, the debtor has the opportunity to discharge ALL debts listed in the bankruptcy petition. In other words, the listed debts are erased and the debtor is no longer liable to pay those debts. Discharge of the debt is the benefit the debtor receives in a bankruptcy.

Outside of bankruptcy, if a creditor elects to settle the debt for a reduced amount rather than pursuing the full obligated sum through garnishment, levy or attachment then often times, the debtor will have a tax consequence on the next year's tax returns. In some situations, the debtor will have to pay taxes on the reduced sum.

Recently, several of my clients have received form 1099-C from a former creditor even though the creditor's debt was discharged in bankruptcy. The debtor is left to ask the question: "Do I have to pay taxes on my discharged debt?". The simple answer is "No!" The following is found on the federal government's website irs.gov.

Debt canceled in a title 11 bankruptcy case is not included in your income. A title 11 bankruptcy case is a case under title 11 of the United States Code, but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court.

How to report the bankruptcy exclusion for canceled debt

To show that your debt was canceled in a bankruptcy case and is excluded from income, attach Form 982 to your federal income tax return and check the box on line 1a. Lines 1b through 1f do not apply to a cancellation that occurs in a title 11 bankruptcy case. Enter the total amount of debt canceled in your title 11 bankruptcy case on line 2. You must also reduce your tax attributes in Part II of Form 982 as explained under Reduction of Tax Attributes, later."1

Clearly, the federal government wants the debtor to have a "fresh financial start" by unyoking the debtor of past monetary obligations. If you find yourself in this situation, I highly recommend you seek a tax professional to assist you in preparing your up coming tax records.

In sum, debts that have been canceled by way of a bankruptcy are not taxable, but they should be reported correctly on any tax record submission to the IRS. Always use caution and seek out qualified professionals to assist you with serious financial issues as discussed.

About the Author:

Thomas E. Trunnel is a Denver Bankruptcy Attorney serving bankruptcy clients in Colorado.

Phone: (818) 509-1173

Website: Denver Bankruptcy Lawyer