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Insolvency as a tax tonic

 

Dear Tax Talk,
In the last two years, I have been in over my head with credit card debt. I decided to go through CuraDebt and have my debts negotiated instead of filing bankruptcy.

I had three negotiated last year; I still have more. At any rate, my gross income shown on my W-2 is only $23,000. I have a car (1996), no house, just an apartment. My debt is now close to $35,000. I am married, my husband is not on any of my liabilities and we file jointly. My question is this: I have received two of the three 1099s for the cancellation of debt. Right now, we are looking at owing $2,500 just in federal taxes. I cannot sleep or eat.

I knew that this would happen, but was told that in most cases if you have more debt than income that it does not need to be included in your income on the 1040. Right now, this is the case for me. Is there anything special I need to do to prove this to the IRS? Or do I just do our taxes without the canceled debt income and use our W-2s? I am getting no answers from anyone. I really need your advice. I am really scared. -- Sarah

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Dear Sarah,
I hope I can help you sleep a little easier. When you're down and out, the last thing you need is a tax headache to add to your woes. Congress agrees with this philosophy and provides an exclusion for canceled debt.

If a lender cancels a debt, they will issue you a 1099-C to report the amount of debt canceled. Generally, this is considered income unless the amount of debt represents a tax-deductible item.

You can exclude the debt from income if you're in bankruptcy or if you're insolvent. Bankruptcy, of course, is a formal process of resolving your debts and it doesn't sound like you declared bankruptcy. The insolvency exception does not require any formal process. You're insolvent if, after the cancellation, your debts still exceed the value of your assets. Insolvency is also measured under state law. For example (although it does not apply in your case), if the state considered your homestead exempt from creditor's claims, then the value of the home would not be considered in determining your insolvency.

Let's assume your car is worth $2,000 and you have nothing else. You're insolvent by $33,000 after the debt in 2003 was canceled so you can exclude the full amount of debt canceled from your income. If you exclude debt forgiveness, you have to reduce any tax attributes you have. Tax attributes are loss carryovers, such as capital losses. If you don't have tax attributes or business property, this would not apply to you.

You need to complete Form 982. If you have no tax attributes or business property, Form 982 is fairly simple. You would check box 1b and enter the amount excluded on line 2. Attach the form to your 1040 for the year of the debt cancellation.


 
-- Posted: Feb. 17, 2004
     

 

 
 

 

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