Blog by BR Accounting and Tax Service

Got Cancelled Debt, How Much is Income?

  • BR Accounting And Tax Service

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I hope you have managed to stay safe and well! We focus on resolving tax issues in Prince William County and throughout the lower Northern Virginia area.

The IRS recently disagreed with a Tax Court case on the insolvency exclusion and pensions. Under the Internal Revenue Code, taxpayers whose liabilities are greater than the value of their assets are allowed to exclude income from canceled debts, up to the amount of their insolvency. Ex. Assets = $550, while liabilities = $600; net worth = ($50). Canceled debt = $70; $70 + ($50) = $20. $20 would be included in your income.

Real life example: In a 2017 court case, the Court held that a retired police officer’s interest in a pension plan isn’t treated as an asset for figuring insolvency because it couldn’t be converted into a lump-sum cash amount, nor could it be assigned, sold or borrowed against. And proof at just how powerful the Internal Revenue Service can be is demonstrated by the Service’s response to the court’s decision. IRS says the Court’s analysis is incorrect, and it will not follow the decision. Bottom line all “perceived” assets are still on the table when it comes to insolvency and debt relief.

In case you were wondering, can a lender collect on a debt after issuing Form 1099-C to the defaulting party subsequent to the debt being cancelled? A district court says, YES. After a couple failed to pay their consumer loan, the lending bank was able to win a court judgment against them. After an attempt to settle the debt, failed to resolve the matter The bank subsequently sent the couple a 1099-C reporting $200,000 of debt cancellation income. Naturally, the couple assumed that the bank’s issuance of the 1099-C had resulted in the debt being forgiven, thus voiding the judgment. However, the court determined that the bank was required by IRS regulations to issue the 1099-C, and in so doing no discharge of indebtedness had taken place.

Hopefully, you never find yourself on the wrong end of a cancelled debt, and in the “crosshairs” of the IRS. Fortunately, the IRC and IRM have avenues by which taxpayers may seek relief overwhelming tax obligations. Tax practitioners who understand how to conduct their clients along these routes will be performing a much-appreciated service., we would be happy to help. Please feel free to contact us