Forgiven debt may impact your income taxes

Consumers who negotiate a debt forgiveness deal with their credit card lender may feel a sense of relief after the agreement is finalized, but many may find that they have a larger tax bill during filing season as a result. In many cases, the IRS considers forgiven debt as taxable income, a lesser-known scenario that many individuals are not aware of until their tax bill arrives.

For example, if an individual owes $15,000 in credit card debt and their lender forgives $10,000 of the balance, it's likely that this amount will be included in the credit card holder's taxable income for that year, according to Bankrate.com. In many cases, the lender will send the individual a 1099 form, but this is not always the case. Even if consumers do not receive these tax papers from a lender, it is likely that the company still sent this information to the IRS.

In some cases, however, individuals may not be on the hook for all types of cancelled or forgiven debt. For example, the Mortgage Debt Relief Act typically allows homeowners to exclude income from debt that is discharged on their principal residence between calendar years 2007 and 2012. This may include foreclosures or refinancing in most cases. According to the current rules, up to $2 million of forgiven mortgage debt falls under this exclusion for married couples filing jointly and $1 million for those filing separately.

In addition, debt that is discharged through a bankruptcy agreement is not considered taxable income. Individuals who are considered insolvent at the time their debt is cancelled may also be excluded from the current rules that govern forgiven balances. By IRS rules, an individual is deemed insolvent when the total amount of his or her debts exceed the fair market value of his or her total assets.

In addition, the IRS also makes an exception for certain types of farm debts. For example, taxpayers who incurred debt directly from the operation of a farm, earned more than half of their income from the previous three years from farming and owed the loan to a person or agency that was regularly engaged in lending, may not see their forgiven debt treated as taxable income.

The rules that oversee the forgiveness of certain types of debt can be tricky and often depend on a variety of factors. For this reason, individuals who have had any debt forgiven, ranging from credit card to mortgage debt, should work with their tax preparer to determine how the cancellation will impact their income taxes.

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Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.

About Liberty Tax Service 
Liberty Tax Service is the fastest -growing retail tax preparation company in the industry’s history.  Founded in 1997 by CEO John T. Hewitt, a pioneer in the tax industry, Liberty Tax Service has prepared over 8,000,000 individual income tax returns.  With 42 years of tax industry experience, Hewitt stands as the most experienced CEO in the tax preparation business, having also founded Jackson Hewitt Tax Service.   

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Posted To: Tax Ranger's Blog By: Tax Ranger On: Wednesday, December 14, 2011
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