As an S Corporation CPA and cancelled debt sub-specialist, I’m seeing more S Corporation Form 1099-C(s), Cancellation of Debt, probably as delayed fallout from the Recession. The tax treatment of S Corporation cancelled debt isn’t covered well in the IRS Form 1120-S instructions, in my opinion. Publication 4681, Canceled Debts, Foreclosures, Repossessions, and abandonment doesn’t deal much with S Corporation cancelled debt either. Even my professional tax preparation software doesn’t handle S Corporation cancelled debt automatically. I still have to essential hand prepare the Form 1120-S, U.S. Income Tax Return for an S Corporation, and do a manual work around to properly file.
I’m a CPA whose firm operates as an S Corporation. This blog site allowed me to specialize in cancelled debt. So this post topic is a good match. If your S Corporation receives a Form 1099-C consider calling for a free consult. (910) 399-2705. Our virtual office means we can help you and your S Corporation regardless of location.
Is the Form 1099-C issued in the S Corporation’s Name?
If it is, this post can be useful. Most S Corporations don’t establish their own credit and S Corporation shareholders guarantee liability personally. So the Form 1099-C might be issued in the shareholder’s name. So here’s a link to my most popular personal cancelled debt post.
The most confusing topics in S Corporation Cancellation of Debt Tax Reporting
- The tax rules for S Corporation cancellation of debt changed in March 2002. We’re looking at 2013 and 2014. Few S Corporation Form 1099-Cs get issued for bankruptcy, rental real estate etc. before that date. But most of the internet chatter still discusses the comparison between the old and new tax reporting rules. I’m sticking to the “new” tax reporting requirement for S Corporations.
- Most Internet chatter compares the S Corporation tax reporting rules on Form 1120-S, U.S. Income Tax Return for an S Corporation for cancelled debt against a Partnership (Form 1065).
The notorious Sec. 108 as applied to S corporation Cancelled Debt
“Cancelled debt on Form 1099-C, Cancellation of Debt, becomes taxable income to the S Corporation unless it can be excluded through an exception or exclusion on Form 982, Reduction of Tax Attributes.”
– Gary Bode, S Corporation CPA
S Corporation cancellation of debt “income” gets recognized at the Corporate level after Sec. 108 is realized and passed through Form 1120-S’s Schedule K-1.
Sec. 108(a)(1) allows for exclusion of cancelled debt income from gross income where the debt discharge:
- S Corporation Title 11 bankruptcy.
- S Corporation insolvency.
- Qualified farm indebtedness if the Farm operates as an S Corporation.
- Is qualified real property business indebtedness; e.g. rental real estate foreclosure, rental estate short sale, rental real estate mortgage loan modification.
Tax Reporting Treatment for Title 11 bankruptcy and Insolvency for S Corporation cancelled debt
Once the Form 1099-C, Cancellation of Debt, gets issued should consult with an S Corporation bankruptcy as part of due diligence. However the favorable tax rules for S Corporation cancelled debt may allow the same result on Form 982, assuming the same financial circumstances. Especially when the S Corporation cancelled debt stems from rental real estate. The combination of insolvency and qualified real property business indebtedness on Form 982 generally do the trick.
The Reduction of Tax Attributes section of Form 982
There are tax positioning strategies to help make S Corporation cancelled debt a free ride with the IRS. But sometimes you can’t control the timing of cancelled debt and the S Corporation essentially delays the tax consequences of cancelled debt until another S Corporation gets sold. The S Corporation must adjust the basis of its other assets meaning an increased gain or decreased loss when they’re sold. The second best thing to paying no tax is paying the tax later.