The new regulations on the taxation of debt settlement have triggered several questions about debt settlement and income taxes. This article tries to cover the most important aspects of it within its limited scope. Let’s start by explaining why the liquidation is taxable. This is due to the fact that once you file for settlement, you must pay a certain amount of money to the creditor. This is the money you save and is considered your income. However, since the income is taxable, the settlement becomes taxable. So you need to pay tax.

Question: Who informs the IRS about the settlement agreement?

Answer: After the new regulations are implemented, creditors are required to report debt settlement agreements to the IRS. Creditors issue the 1099-C to the IRS which reports the details of the settlement agreements that are taking place.

Question: What is a 1099-C and what does the IRS do with it?

Answer: 1099-C are the details of debt settlement agreements that creditors agree to. It includes information such as the name of the client, the debt forgiven, etc. After the IRS receives this from the creditor, it will send it to the debtor. The debtor will then have to account for the same in the TI statement. If the debtor fails to do so, the IRS will file a federal tax lien and take action against the debtor in the form of penalties and interest.

Question: Can tax settlement be avoided?

Answer: Yes, it can be avoided in several situations. In the event that the debtor can prove insolvency during the liquidation, it becomes non-taxable. The forgiven debt is not taxable if the debtor’s indebtedness is due to any loss in a real estate deal or if the forgiveness was the result of a bankruptcy proceeding. In addition, if the forgiveness is treated as a gift, taxation of the debt settlement can be avoided.

Question: How to report bankruptcy to the IRS?

Answer: Filling out form 982: Reduction of Tax Claims Due to Indebtedness Discharge issued by the IRS together with the tax return. The debtor can also alternatively enclose a letter with the detailed calculation of total debts and total assets during the liquidation along with the tax return.

Question: Is there any specific amount of forgiven debt that is taxable or is any amount forgiven taxable?

Answer: If the amount of the debt forgiven is more than $600, it becomes taxable!