Do I Owe Taxes for Debt I Wiped Out in Bankruptcy?

Cancellation of debt

Possibly. But there are reasons you may not have to pay tax created from filing bankruptcy. Let me explain.

Self-employed workers receive a 1099 for their wages instead of a W-2 form that you get if you are employed by a company, etc. But there is a type of 1099 form that, regardless if you are self-employed or employed by someone else, you may receive from one of the creditors within your bankruptcy. This is form is called a 1099C.

A 1099C form is utilized by a creditor when a portion or all of a debt is wiped out or forgiven. The creditor is required to report this debt to the IRS if the amount is greater than $600.00. The IRS then deems the cancelled or forgiven debt as income which then must be reported on your tax return as additional income.

Your creditor should mail a copy of the 1099C form to you when they file the 1099C form with the IRS. If you did not receive a copy, you of course would not know to report this income. The IRS will send you a notice explaining that you did not include all income on your tax return per a creditor(s) filing a 1099C form. Now you owe penalties and interest on the amount of taxes owed stemming from the 1099C form.

But wait, there are several reasons why you might not have to pay taxes on the forgiven or canceled debt.

IRS Publication 4681 lists some of the exceptions that would exclude you of the penalties, interest, and taxes stemming from a 1099C.

  • The debt stemmed from the foreclosure of a residence
  • The debt was discharged through a bankruptcy
  • The debt was a result of the modification of a home loan under the Homeowners Affordable Modification Program (HAMP)
  • The debt was a qualified farm debt
  • The debt would have been a deductible payment
  • The debt was forgiven as a gift to you or as a bequest in a will If one or more of the above exceptions applies to your debt, you should list it on IRS

Form 982 and file this form with your tax return in order to prevent owing taxes from this activity.

Bottom line, be sure that your tax preparer knows that you filed bankruptcy. Have your tax preparer attach IRS Form 982 to your tax return. Your tax preparer should check the box in Part 1 that states “Discharge of indebtedness in a title 11 case”. Title 11 properly identifies bankruptcy in reference to the debt (it is not referring to the type of bankruptcy you filed such as a Chapter 7, Chapter 13, etc). A copy of your bankruptcy discharge should be attached to the IRS Form 982.

If you receive the 1099C after you have already filed your tax return, then you will need to file an amended return. Do not ignore or disregard these forms. It is in your best interest to deal with this situation now rather than letting it sit and penalties, interest, etc build.

Disclaimer: This blog is intended as general information purposes only, and is not a substitute for legal advice. Anyone with a legal problem should consult a lawyer immediately.

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