A client called us the other day and asked, "Do you have to pay tax after settlement?"

In most cases, the answer is NO.

When you negotiate a settlement on a debt you owe, let's say a credit card with a $10,000 balance is settled for $4,000 (yes it is very possible!), the amount that is FORGIVEN may be added back into your taxable income for that year.

At the end of the year, you will receive a 1099-C in the mail that states that the creditor has reported the $6000 of forgiven debt to the IRS (any amount forgiven over $600 may be subject to IRS reporting).

What do you do when you receive a 1099-C?

First, if your accountant or tax preparer tells you that you will have to pay tax on that amount, you probably need to find a new accountant!

Why?  It has been my experience that most accountants and tax preparers are not aware or experienced in how to treat 1099-C for settlements or forgiveness.

IRS Form 4681 explains that certain amounts of "forgiven debt" may be excluded from taxable income.  Basically, if AT THE TIME OF FORGIVENESS, you were INSOLVENT (your debts were greater than your assets), then the forgiven amount IS NOT included as taxable income.

List all of your assets:

• Any equity you have in your home
• Net or depreciated value of your cars, boat, etc.
• Net value of your jewelery, stocks, bonds, etc.
• Cash

Now list all of your debts:

• Mortgage (First and Second) on your home
• Lines of credit
• student loans
• credit cards
• medical bills
• personal loans

Subtract the DEBTS YOU OWE from your ASSETS.  If the number is negative, then you are "insolvent" according to the IRS. Complete IRS Form 982 and check the appropriate boxes to show that this amount should be excluded.

The moral of this story, don't think that just because your accountant or anyone else tells you that you must automatically pay tax after settlement, that it is always true.

photo by: Alan Cleaver

If you have had a debt "forgiven", and receive a 1099-C, how do you avoid paying taxes?

Any amount of "forgiveness" over $600 can be reported to the IRS and if so, then you would receive a 1099-C form.  The IRS says that any debt that is settled for less than the full balance must be included back into your income and you must pay the resulting taxes!

Instructions from the IRS can be found in IRS 4681.

In the instructions, you will find an explanation of "INSOLVENCY".  Of course, when reading anything from the IRS, it is not very easy to understand or interpret.

Basically, the information states that if at the time of the forgiveness, you were INSOLVENT, then the amount of forgiveness IS NOT INCLUDED as additional income and therefore you would not pay any additional tax.

Let's look at an example:

After many harassing phone calls from your creditor, you are able to settle your account for less than the balance.  When it came time to file your taxes, you receive a 1099-C which would lists the debt, the debtor and the amount that was "forgiven".

What do you do now that you have received a 1099-C?

First you need to determine if you were INSOLVENT at the time the debt was forgiven. To determine if you were insolvent :

1.  List all of you assets (things you own that has positive equity):

• Equity of your home
• Net (depreciated) value of your cars, boat, etc.
• Net value of jewelery, stocks, bonds, etc.
• Savings or investment accounts
• Cash in the bank

2.  List all of the debt you had at the time of forgiveness:

• Mortgage (1st and 2nd)
• Auto, boat or other loans
• Credit card debt
• Medical debt
• Personal loans to...

3.  Now subtract your LIABILITIES (that's all the debt) from your ASSETS.

Is the result a NEGATIVE number?  If so, you WERE INSOLVENT!

When filing you tax return, you will need to complete IRS form 982 and submit with your tax return.  Most accountants and/or tax preparers are not aware of the exceptions to paying tax on "forgiven" debt, so you need to be very careful.

Although we are not attorneys nor tax accountants, we can help guide you through the process.

If you would like a FREE CONSULTATION, just let us know.

BOTTOM LINE...DON'T PAY ANY MORE TAX THAN YOU ARE LEGALLY REQUIRED...IT'S YOUR MONEY AFTER ALL!!!

 photo by: MoneyBlogNewz

3...2...1...HAPPY NEW YEAR! 

It's that time of year again.  Time to ring in the New Year and make your resolutions.  But before the ball drops on December 31st, follow these 3 End of the Year Tricks to Save Money on Taxes!

#1: Donate to your favorite charity

Donating to charity is a great way to save money on your taxes.  When you make a donation to a qualified organization, you are eligible for a tax deduction.  If you're not sure tha an organization qualifies, use this IRS charity search tool, to look up organizations by name and location. In order to make your donation tax deductible, it has to be made before the end of the year and you must itemize deductions on your tax return.

How Do You Itemize Deductions?

Itemizing is simple and it can save you a ton of money. Each year you are allowed to claim either a standard deduction for your tax filing status or you can list out your deductions on Schedule A of IRS Form 1040.

The standard deduction in 2011 for a single taxpayer is $5,800. If you spent more than $5,800 during the year on certain types of deductible expenses—like charitable donations, mortgage interest, and a portion of your medical care—then you will save money by itemizing.

#2: Contribute the Maximum Ammount towards your Retirement Account at Work

If you have a retirement plan at work (401(k), 403(b), 457, or government Thrift Savings Plan) Find out how much you’ve contributed this year. In 2011, you can contribute up to $16,500 or $22,000 if you’re 50 or older.

Every bit that you contribute to a retirement plan on a pre-tax basis is income that you don’t pay tax on until you take a future withdrawal.

To do this, contact your benefits administrator at work to increase your final contribution for the year so you can max out the account or get as close as possible.

#3: Prepay as Many Deductible Expenses as You Can

Because you have to itemize to be eligible to claim most of available deductions, prepaying increases the likelihood that you’ll have enough to itemize in the current year.

Here are some deductible expenses you can prepay:

• Home Mortgage Interest: Pay your January mortgage payment by December 31 so you have extra interest to deduct for this year.

• Property Taxes: Most people receive a property tax bill in November, but it isn’t due until the following year. Paying the tax before the end of the year gives you another deduction, and maybe even an early-pay discount.

• Student Loan Interest: Even if you don't itemize, you are allowed to deduct up to $2,500 of interest paid on a student loan. However this is subject to annual limits on your income. By prepaying your January student loan payment by December 31, you will have a little more tax savings for the current year.

You can find what additional deductible expenses you can prepay by looking at a Schedule A.  (medical costs, legal fees, and unreimbursed business expenses, etc)

By taking the time to do a little End of the Year tax planning, you can save a bundle! If you want to make sure you are saving as much as possible, consider meeting witht a tax professional.  They review your situation and make sure you are not paying any more tax than absolutely necessary!

Mortgage Forgiveness Debt Relief Act

In the past, homeowners using short sales or deeds in lieu of foreclosure were required to pay tax on the amount of their forgiven debt. However, the Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) changes this for certain loans. This Act, which has been extended through 2012, allows taxpayers to exclude income from the discharge of debt on their principal residence.

Under federal law, a creditor is required to file a Form 1099-C whenever it forgives or cancels a loan balance greater than $600. This may create a tax liability for the debtor because the canceled debt is considered “income” for tax purposes.

The Mortgage Forgiveness Debt Relief Act excludes the cancellation of the complete debt up to $2 million.  According to the IRS, the exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

The new law provides tax relief if your deficiency stems from the sale of your primary residence, or the home that you actually live in. Vacation homes, for example, do not qualify. Here is an overview of the rules:

• Loans for your primary residence. If the loan was secured by your primary residence and was used to buy or improve that house, you may exclude up to $2 million in forgiven debt. This means you don’t have to pay tax on the deficiency.

• Loans on other real estate. If you default on a mortgage that’s secured by property that isn’t your primary residence (for example, a loan on your vacation home), then you’ll owe tax on any deficiency.

• Loans secured by but not used to improve primary residence. If you take out a loan, secured by your primary residence, but use it to take a vacation or send your child to college, you will owe tax on any deficiency.

Insolvency exception to tax liability

If you don’t qualify for an exception under the Mortgage Forgiveness Debt Relief Act, you might still qualify for tax relief. If you can prove you were “legally insolvent” at the time of the short sale, deed in lieu, or foreclosure, you won’t be liable for paying tax on the deficiency.

Legal insolvency occurs when your total debts are greater than the value of your total assets (your assets are the equity in your real estate and personal property). To use the insolvency exclusion, you’ll have to prove to the satisfaction of the IRS that your debts exceeded the value of your assets.

photo by: Mike Licht

We get dozens of calls each year around tax time asking about the 1099-C IRS form.

If in the last taxable year you or a Debt Settlement Company had negotiated a settlement on one of your unsecured accounts, you will most likely receive a 1099-C form if the amount was over $600.

Unfortunately, many tax preparers don't know how to have settled or forgiven amount excluded from taxable income.

The most important question is:

"At the time of forgiveness (IRS term for settlement), were you INSOLVENT?"

What is INSOLVENT?

In IRS Form 4681, it gives the typical, a little hard to understand explanation of what the IRS deems INSOLVENCY to mean.

Basically, if your total assets are less or equal to your total liabilities, then you were INSOLVENT at the time of forgiveness and therefore the forgiven amount is excluded from additional taxable income.

What do you need to do?

List all of your assets:

• Equity in your home
• Equity in you car or cars
• Cash in the bank or retirement accounts
• Net value of any other property (rental, furniture, jewelry, collections, etc.)

List all of your liabilities:

• mortgage you still owe (maybe a 2nd as well)
• Amount you still owe on your car or cars
• All of your unsecured debt (including the final balance of the debt forgiven.
• All loans, student loans, medical bills outstanding, etc.

Subtract the total liabilities from total assets.

If you are equal or negative, then you were INSOLVENT at the time of the settlement or forgiveness and therefore the amount WILL NOT BE INCLUDED AS TAXABLE INCOME.

When you mail your tax form, you will include:

• A brief (brief) statement that you were INSOLVENT at the time of the settlement and that this amount should be excluded from taxable income.
• Copy of your Assets vs. Liabilities
• IRS Form 982

You can get a copy of IRS Form 982 by clicking here.

Put your name and Social Security number in the boxes at the top.

Check the box in Part 1, 1-b that states, Discharge of indetedness to the extent insolvent (not in a title 11 case).

That should do it.

If you would like more information about the IRS's definition of INSOLVENTCY, see IRS Form 4681, page 5.

If you feel overwhelmed and need some FREE ADVICE, or you need more help with the 1099-C, please click on our FREE DEBT SUMMARY link.

 photo by: Horia Varlan

Do I have to claim credit card debt forgiveness as taxable income because I had some debts settled last year? 

One of our clients had received a letter from the IRS regarding her inquiry as to the "taxable income" status of credit card debt forgiveness.

The IRS wrote:

"Claims of insolvency must be supported by a listing of assets and liabilities at the time the debt was canceled.  You may include Form 982 or a simple cover letter claiming insolvency."

When you have a debt settled (or in IRS terms, "forgiven"), if the amount forgiven is over $600, the creditor may send that information to the IRS.

If so, you will receive a 1099-C form.  At first, it looks as if you will have to include the entire amount as taxable income, but if you read closely, their are exceptions!

• The main exception or exclusion of the forgiveness as taxable is as the IRS letter stated above, if at the time of settlement you were basically insolvent, then the amount IS NOT INCLUDED AS TAXABLE INCOME.

IRS Form 4681 explains the "exclusions", and there are several, but the main one you should be concerned with is INSOLVENCY.

The form states, "Do not include a canceled debt in income to the extent that you wee insolvent immediately before the cancellation.  You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities exceeded the FMV (Fair Market Value) of all of your assets immediately before the cancellation."

Unfortunately, many tax advisers and accountants are not aware of this exclusion and tell their clients that they must pay more taxes, when they shouldn't have too!

If you have had unsecured credit card debt settled last year, then you should:

• Provide a simple financial profile of your assets vs. liabilities.  For most people, their liabilities are much more or at least equal to their net assets.
• If your tax preparer does not have form IRS Form 982, click here for a copy.
• A simple letter stating your circumstances at the time of forgiveness (hand written) may also help.

If you have had settlements prior to 2010, and you think you paid taxes when now you realize you shouldn't have, then contact your tax preparer with this information or contact the IRS yourself.

You may get back all of the extra tax you paid!

If you or a debt management company has successfully negotiated a settlement of your credit card debt, and the amount is over $600, you may receive a 1099-C.

It basically states that unless the amount forgiven (IRS terminology for settlement) is exempt, then it has to be included as additional income subject to normal taxation. 

So, how do you determine if the forgiven amount is exempt?

According to IRS Form 4681, there are several exemptions to including forgiven amounts back into taxable income.

For the purpose of this article, let's focus on the settlement or forgiveness of credit card or unsecured debt.

On page 4 of IRS Form 4681, there is an explanation of  "INSOLVENCY".  As usual, the government has a hard time explaining the rules (I think they do it on purpose!), but basically the rule states:

If at the time of the settlement or forgiveness you were INSOLVENT, then the amount of the forgiveness IS NOT INCLUDED as additional taxable income.

How do you determine if you were insolvent?

At the time of the settlement, you need to show that your liabilities were only equal to or greater than your assets.

You need to complete a basic budget showing all of your income, outgo, and assets:

• Equity in your home
• Net value of your automobile(s), boat, etc.
• Net value of jewelery, stocks, bonds, etc.
• Savings or investment accounts
• Net furniture value, coin collections, etc.

For most people who have negotiated a settlement of their credit card or cards, they usually do not have any real assets and therefore the amount forgiven is not included as additional taxable income.

You will need to complete IRS Form 982.  You will check a couple of boxes and sign, and along with the Budget Worksheet, turn in with the 1099-C and your normal tax return.

Don't be surprised if your tax preparer or accountant is not really up on this procedure!  You might want to download IRS 4681 for their review.

We have helped dozens of tax preparers and accountants deal with the 1099-C issue and would be glad to assist.

Got Questions? We've got ANSWERS!

877-492-4109

photo by: alancleaver_2000