Tax Consequences After Bankruptcy: 1099C & Cancellation of Debt “Income”

A huge drawback of debt settlement – outside of a bankruptcy – is the risk of receiving an I.R.S. Form 1099C.  When a lender forgives or cancels a debt in excess of $600, they must report this to the IRS (unless the underlying debt was secured by the borrower’s principal residence).  Therefore, when a debt is cancelled or forgiven, the borrower will receive a 1099-C.

As soon as a lender forgives the borrower’s obligation to repay debt, the amount of that debt becomes a “tax attribute” or “income,” and that “phantom income” is subject to taxation. The cancellation of debt thus becomes taxable income.  The resulting tax liability is often more troublesome than the original debt that was forgiven.

Now, assume the borrower files a chapter 7 or chapter 13 bankruptcy, and discharges his debts.  What happens if the lenders issue a 1099-C after the bankruptcy is discharged?  Does the borrower have to pay tax on the debts that were discharged?  Fortunately, the answer is “no.”

When a borrower receives a Form 1099-C after a bankruptcy discharge, he or she must file an IRS Form 982.  The form is entitled “Reduction of Tax Attributes Due to Discharge of Indebtedness.”  The Internal Revenue Service explains Form 982 in IRS Publication 4681.

For a free and confidential consultation with an experienced bankruptcy lawyer, give me a call or send me an e-mail.  We have offices in Paulding County – Dallas; Bartow County – Cartersville; Gordon County – Calhoun; and an office in Dalton, GA, serving Whitfield, Catoosa and Murray counties.

Brian R. Cahn | www.NorthGaBankruptcy.com

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Posted on November 14, 2011, in Bankruptcy and tagged , , , , , , , , , , , , , , , , , , , , , , , , , , . Bookmark the permalink. Leave a comment.

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