Is the Debt Discharged by Bankruptcy Taxable?

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  2. Is the Debt Discharged by Bankruptcy Taxable?
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The IRS often considers canceled debt or discharged debt as income – leaving taxpayers responsible for reporting that income on their tax return. But this isn’t always the case. This rule does not apply to all discharged debt.

What is a Forgiven or Cancelled Debt?

When a creditor agrees to or is prohibited from pursuing a consumer for money owed, the debt is considered forgiven or canceled. The consumer no longer owes a forgiven or canceled debt. Forgiven/canceled debts are usually not considered income when the debts are forgiven/canceled due to bankruptcy (although it’s important to note the word usually in this sentence). The rules vary when debts are forgiven outside of bankruptcy, but sometimes, you don’t have to report those as income either.

How To Handle Debts Discharged in Bankruptcy During Tax Filing:

In most cases, debtors who file bankruptcy are usually not required to include the discharged debt as taxable income. If you are a bankruptcy filer and you receive a Form 1099-C from a lender showing the amount of debt that was canceled or discharged during bankruptcy, discuss the situation with your tax professional. They may advise you to attach Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment),” to your income taxes to show the IRS that the discharged amount is excluded from income by Code Sec. 108.

If a Debt Was Discharged Before You Filed Bankruptcy:

In some bankruptcy cases, petitioners attempted to alleviate their financial crisis by working with their creditors directly. This may have resulted in partial debt settlement or one or two debts being settled before filing bankruptcy. If you have a canceled or forgiven debt before filing bankruptcy, you must include the amount of the debt stated on the Form 1099-C you receive on your tax return if the lender filed it before you file for bankruptcy. Timing is everything. When this happens – it’s no longer debt; it’s income or money you borrowed that you don’t have to pay back. Bankruptcy can only cancel debts that exist at the moment you file your petition.

Do You Have to Report Debts Discharged in Bankruptcy as Income?

In some cases, bankruptcy petitioners do have to report debt discharged in bankruptcy as income. Make sure to consult a tax professional you trust about the exact details of your bankruptcy case and your situation before assuming you need to claim your discharged debt as income.

If you need to file bankruptcy, and you are postponing getting in touch because you are ashamed of your financial situation, please don’t hesitate any longer. Most bankruptcy offices in the Chattanooga area don’t have a single Consumer Bankruptcy Specialist on staff. Our office is the only one in Chattanooga with two. You are in good hands with Kenneth C. Rannick P.C.

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