IRS Insolvency Worksheet tips by Cancelled Debt CPA tax preparer

Cancelled debt CPA tax preparers hear and read lots of confusion over the IRS insolvency worksheet. Here’s a list of names I’ve heard for it:

• 982 form insolvency.
• 1099-C insolvency.
• Publication 4681 insolvency.
• Exclusion of debt insolvency.
• Insolvent paper.
• 1099-A insolvency.
• IRS bankruptcy sheet.
• 982 Part I insolvency.

I’ll offer an overview of the:

• IRS Insolvency Worksheet.
• Give some tips I’ve learned a cancelled debt CPA.
• Answer some FAQs

The most frequent confusion over the IRS insolvency worksheet?

While the IRS insolvency worksheet calculates your insolvency (the amount you’re insolvent), insolvency is only one way to exclude the amount of debt discharged in Box 2 of Form 1099-C, Cancellation of Debt, from becoming taxable income on Line 21 of Form 1040.

Tip: The Golden Rule of Cancelled Debt tax preparation? Pay no tax on the amount of debt discharged in Box 2 of Form 1099-C without squeezing every dollar of exclusion out of Form 982, Reduction of Tax Attributes.

The IRS Insolvency Worksheet doesn’t prevent you from using other Form 982, Part I exclusions

You can use more than one exclusion in Form 982 Part I.

The IRS Insolvency Worksheet uses the date of identifiable event in Box 1 of Form 1099-C, Cancellation of Debt

It’s not automatically December 31st.

You may be able to challenge the date on Form 1099-C, Cancellation of Debt

The lender has to follow IRS protocol when issuing Form 1099-C.

Tip: Consider calculating the IRS Insolvency Worksheet for the date you believe correct. If there’s decreased tax liability using that date maybe you can get the bank to correct Form 1099-C, or make a case with the IRS for a better date.

Box 5 of Form 1099-C; Check here if the debtor was personally liable for repayment of the debt

If Box 5 of Form 1099-C isn’t checked, you may not be responsible for the debt discharged in Box 2 of Form 1099-C. But I wouldn’t rely on it. The IRS could audit your tax return and generate a Notice CP2000 proposing tax on the amount in Box 2 of Form 1099-C.

Tip: Consider providing an explanation and documentation with your tax return proving you weren’t responsible for the debt. Otherwise the IRS might audit you despite Box 5 being unchecked.

Tip: Consider calculating the tax consequences of a Form 1099-C using the IRS insolvency Worksheet. If there are no present or future tax consequences, maybe it’s better to include the cancelled debt and then exclude it on Form 982, Reduction of Tax Attributes, even if Box 5 isn’t checked.

Recourse and Non Recourse Loans in the Liability section of the IRS Insolvency Worksheet

• A recourse loan is when you are personally responsible for paying back the loan.
• A non recourse loan means you aren’t personally responsible to pay back the debt.
  • A common example is a mortgage for rental real estate where the loan is secured by the rental property only, without you being on the hook for it.

You don’t have to file the IRS Insolvency Worksheet with your tax return

You just enter the result from the IRS insolvency worksheet to Form 982.

Tip: Keep the worksheet, and it’s documentation, for your records. It’s reasonable to assume the IRS nay ask for it.

You can use some estimates on the IRS Insolvency Worksheet

Let’s use the Jewelry line in the asset section of the worksheet as an example. Even though you paid, say, $1,000 for your jewelry, the average person couldn’t sell it for that amount in a reasonable amount of time. You’d use a Craig’s list value or pawn shop value for the jewelry for the insolvency worksheet. But if have an $8,000 engagement ring, maybe you should get an appraisal for it as documentation for the insolvency worksheet.

Married Filing Jointly status and Married Filing separately status

Sometime a married couple can exclude more of the cancelled debt from a Form 1099-C by filing separate tax returns allowing them to calculate only their own insolvency for the worksheet.

Tip: check the total amount of tax due for both methods, not just of the amount of discharged debt you can exclude on Form 982

When possible back up IRS Insolvency Worksheet numbers

With larger dollar value assets and liabilities try to back those numbers up with documentation. For example your mortgage lender can provide a statement for the outstanding balance for a given date. A real estate broker can give a value for your home on a given day. Save documentation with insolvency worksheet for seven years.

Modifying the IRS Insolvency Worksheet to help with the Reduction of tax attributes section of Form 982

Tip: I usually add a column to the assets section of the IRS insolvency worksheet asset section to list the purchase price of your assets. Often you’ll need those numbers for Part II of Form 982.