Insolvency and Cancelled Debt | IRS Form 982 and 1099-C | CPA Wilmington NC

Cancelled debt is reported to both you and the IRS on Form 1099-C. This becomes Taxable Income on Line 21 of Form 1040. Unless you qualify for an exception or exclusion, which you report on Form 982. Insolvency is one exclusion.

What is Cancelled Debt?

Examples;

• You negotiate your credit card debt, getting the company to accept $4,000 to settle a balance of $10,000. That “forgiven” $6,000 is cancelled debt and generally included on Line 21 of Form 1040 as taxable income.
• You have a short sale on your home and the mortgage company “forgives” the remaining mortgage amount of $6000. That “forgiven” $6,000 is cancelled debt and generally included on Line 21 of Form 1040 as taxable income.

What is Form 1099-C?

The lender, in the above examples, reports the $6,000 cancelled debt to both you and the IRS on Form 1099-C in January (for the past calendar year). It lists your name, Social Security number, the amount of cancelled debt and, usually, the date it was cancelled.

Cancelled Debt automatically becomes Taxable Income on Line 21 of Form 1040 unless you file Form 982

Often, bad fortune and poor finances cause cancelled debt. So making it taxable income might seem unfair. Especially since it probably feels like you’re being taxed on money you never had. The IRS has multiple exceptions and exclusions that may allow you to avoid being taxed on some, or all, of the amount listed on Form 1099-C. Insolvency is one exclusion and is reported on Form 982.

“Insolvency immediately before the cancelled debt is one of the IRS exclusions that may allow a taxpayer to avoid paying Income Tax on that cancelled debt. File tax Form 982 with your Form 1040.”
Gary Bode, Wilmington NC CPA and tax accountant

Disclaimer

Things become more complicated if the cancelled debt is business related because insolvency now factors in “tax attributes”, which involves adjusting the basis of your remaining assets. As with many IRS issues, there are wrinkles within wrinkles. You can’t reasonably use this simple post as a basis for self tax preparation on a complex tax issue. At the very least you’ll need to do substantial research on info presented on IRS.gov., starting with Publication 4681. This is just a primer. We advocate self preparation of tax forms when it reasonable to do so. But insolvency / cancelled debt / Form 982 is an area where it is often unreasonable to self prepare your tax return.

The Insolvency Exclusion for Cancelled Debt on Form 982

Per the IRS: you were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation. Which seems straight forward. Here’s an example using our opening scenario above. Our taxpayer owed $10,000 to one credit card company and $7,000 to another. So you have liabilities of $17,000 immediately prior to the cancelled debt of $6,000 and only a total asset value of $8,000, for an insolvency amount of $9,000. Since the insolvency is more than the cancelled debt, the entire $6,000 can be excluded from taxable income, in this simple example, by properly filling out Form 982 and filing it with Form 1040.

If you’d like a free initial consult with a tax accountant in a Wilmington NC CPA firm, please call us at (910) 399-2705.

Caution in using Insolvency and Form 982

Anytime you’re excluding Income from Taxable Income, it is probably a matter of interest to the IRS. Remember, cancelled debt is automatically Taxable Income unless you can use an exception or exclusion on Form 982. It is prudent to recognize that the IRS may scrutinize and then audit such a return. While some folks could self prepare a tax return involving cancelled debt, insolvency and Form 982, we feel professional help is usually warranted.

Reading any of our posts should give you a better feel for our expertise and proactive attitude, especially on tax preparation issues. While we’re a CPA firm in Wilmington NC, we serve a larger region. CPA licensure has now become essentially national, instead of being limited to a single State, through the Portability Act. Email, phone calls, Skype, faxes, scans, etc. means we can sometimes offer our services to distant clients without sacrificing quality.