Cancelled Debt is Considered Taxable Income

For anyone who's ever been in a serious debt, getting the credit card company or any other creditors to reduce or even cancel your debt is like the best thing that could ever happen to you and your family. You record will be clear, and you no longer will have the burden of all that debt hanging over your head. Often, people do not realize that if they're not careful, and don't prepare properly, then they are actually setting themselves up for a probable IRS trouble. The bad news is that they can be taxed on the amount of debt that is forgiven as that will be considered as taxable income. So the next time you avail of this benefit, make certain that you understand that you will be partly indebted to the IRS for this. That's the general guideline concerning this matter.

Credit was quite easy to accumulate until the recent years. For the earlier part of the decade, many could get loans and be approved for credit cards with relatively no difficulty. Many people spent uncontrollably and accumulate substantial sums of debt. Without any real limits, they eventually spent much more than they could afford.

Banks understand that sending people to jail because of massive debt is illegal. This is why in certain occasions, they hire specialized firms to take on the responsibility of collecting money from delinquent borrowers. These firms will be compensated by the banks on a percentage basis, depending on how much they've collected from the borrowers. Now, back to reduced or cancelled debts. Take for instance the case of someone whose debt of $20,000 was reduced to $10,000 as the other half was forgiven. Here, the IRS will consider $10,000 as taxable income and you will be obligated to pay taxes on this.

Because creditors will send the IRS a copy of your Form 1099-C, the latter will be informed of the debt reduction. This will be treated as part of your other income, which is written on line 21 of Form 1040. In the scenario above, you'll be required to pay a certain portion of $10,000 to the IRS, and not anymore to your creditors. Therefore, tax reduction will lead to more taxes as this will be added on top of your regular and state taxes. This scenario clearly shows why there's a need to understand the implications of a tax reduction first before subjecting yourself into one.

The bad news is, the IRS can send you to jail if you don't settle your tax debts. Good thing that remedies regarding these issues are available. In a hypothetical sense, if your debt on your $200,000 home loan is reduced to only $100,000, naturally, you are to claim to the IRS the other 50% as part of your other income. The thought of paying taxes on that amount alone is already difficult for many taxpayers. Fortunately, Congress felt that in a situation like this, taxpayers were being subjected into a hole they would never be able to climb out of and that it would be better to give them assistance in a time of such need. In 2007, a law was passed stipulating that any tax reduction amounting up to $2 million and that is attached to a person's primary residence shall be excluded from the 2007, 2008 and 2009 tax returns. So in our example, you're allowed not to pay taxes on the $100,000 worth of tax reduction. The said law is just among the courses of action related to tax reductions, there are still more. If you want to avail of those, be certain that you have asked for the help of a tax professional, otherwise, you might be in another IRS problem once again.

Darrin T. Mish is a Nationally recognized Attorney whose practice focuses on representing clients across the United States with IRS Problems. He is AV rated by Martindale-Hubbel and is a member of the American Society of IRS Problem Solvers and the Tax Freedom Institute. He has been honored by a listing in Martindale-Hubbel's Bar Register of Preeminent Lawyers. His passion is providing IRS help to taxpayers with both individual and payroll tax problems. He teaches attorneys, CPAs and Enrolled Agents in the finer aspects of IRS representation all around the United States. He can be reached at his website at http://www.getIRShelp.com

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