Tax Implications of Debt Relief

With the down turn in the economy, many taxpayers find themselves in debt over their heads and end up settling their debts for less than what is owed, or have their property repossessed or foreclosed upon.  All of those actions will result in the individual being relieved of debt.  In the eyes of the tax code, debt relief is treated as income, and the banks, lenders, etc., are required to issue a 1099-C reporting the debt relief income attributable to the taxpayer.  That debt relief income is taxable to the taxpayer unless he or she qualifies for relief provided under provisions of the tax code.

Taxpayers can exclude debt relief income from their tax return by using what is called the “insolvent taxpayer exclusion.”  Under this provision of the law, a taxpayer may exclude debt relief income to the extent their liabilities exceed their assets.  In addition, when adding up the assets, those assets protected under his or her state’s bankruptcy law can be excluded.  If a taxpayer’s home is foreclosed upon, he or she may also be able to exclude home acquisition debt relief income under a special provision that applies for tax years 2007 through 2009.

Please call our office if you have questions regarding debt relief and its tax implications on your specific situation.

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