Did You Know You Might Owe Taxes On An Obligation That’s Forgiven? Here’s How It Works.

tax form with two silhouettes

When you owe creditors money that you can’t afford to repay, sometimes you may be able to get the balance forgiven or otherwise canceled. When this happens, you no longer owe your creditors the money that you used to owe them.

The IRS, however, usually treats such canceled obligations as income that you’ve received. Income that you could owe taxes on. If you fail to report it or fail to pay your taxes on the canceled obligation, you’ll end up owing penalties and interest and over time, that could be just as big of a hassle as your original balance.

Note: If you have any tax trouble or owe more than $10k to the IRS or state but can’t pay in full, contact our firm today. We help people find tax relief, file years of unfiled tax returns, and sometimes settle their outstanding tax obligation for a fraction of what’s owed.

When Do I Not Owe Taxes On Forgiven Balances?

In some cases, you may get an exemption and there are some circumstances in which you won’t owe taxes.

Your balance is discharged through bankruptcy proceedings:
If you are in serious financial trouble, you may file for bankruptcy and have your balances discharged by the court. Such balances, while they are forgiven, are not considered taxable.

You’re insolvent:

When you are able to settle with a creditor by paying them less than you owe them, your financial situation may be bad enough that you owe, in general, more than you own. If you are considered financially insolvent in this way by the IRS, you may have either part or all of your balances excluded from taxation. If you believe that you may qualify for insolvency exemption, you should hire a tax resolution professional to help make sure.

A canceled balance from friends or family:
If you borrow from friends or family and have them forgive it, the money forgiven is considered a gift, and is not taxable income.

Tax-deductible interest:

If a balance that is forgiven includes interest that is tax-deductible, the interest component does not need to be reported as taxable income. Discharged student loans are also usually exempt from taxation.

Including the forgiven balance in your tax return

If you don’t tell your tax professional about the forgiven balance, in most cases, you won’t know about paying taxes on forgiven balances until you receive a notice in the mail about it. Usually, a creditor who forgives you over $600 sends you a 1099-C form stating the amount forgiven. If the balance forgiven is exempt, you may need to fill out a Form 982 to state how much should be exempt, and why.

What do you do if you pay taxes on forgiven balances that should be excluded?

If a balance forgiven is actually exempt from taxes, but you still pay, you’re allowed to amend your tax return for three years. You simply need to file Form 1040X, and mention your exemption on Form 982.

Working with forgiven balance can be complex. It is usually a good idea to hire a tax resolution professional to work out the details.

OWE BACK TAXES?

Our firm specializes in tax problem resolution. We serve clients virtually so don’t hesitate to reach out.  If you want an expert tax resolution specialist who knows how to navigate the IRS maze, reach out to our firm and we’ll schedule a no-obligation confidential consultation to explain your options to permanently resolve your tax problem.

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