Will I Have To Pay Taxes On Debt Discharged In Bankruptcy?
If you have ever had debt forgiven by a creditor, especially before a bankruptcy case, you may know that forgiven debt is usually taxed. To be sure, if you owe a debt and work out a settlement agreement with the creditor to pay a portion of what you owe in order to have the remaining debt forgiven, any amount that is forgiven will count as income. As such, you will be required to pay taxes on the amount of forgiven debt. If you only have a small amount of debt forgiven by a creditor, you may not owe a significant amount of money. However, if you have tens of thousands of dollars in debt forgiven—or more—you could end up owing a significant amount of money when it is time to file your taxes.
Given that forgiven debt is taxed under these circumstances, you may be concerned or wondering about debt that is discharged in a consumer bankruptcy case. If you have debt discharged when you file for Chapter 7 bankruptcy, or at the end of your Chapter 13 bankruptcy case, will you be required to pay taxes on the amount of debt discharged? In short, discharged debt is different from forgiven debt, and you will not owe taxes on the amount. Our West Palm Beach bankruptcy lawyers can explain in more detail.
Understanding Canceled, Forgiven, and Discharged Debt
Before we discuss the differences between debt that is forgiven by a creditor and debt that is discharged in bankruptcy, we want to clarify some of the terms that are used to describe these actions. The Internal Revenue Service (IRS) explains that any debt forgiven or discharged for less than what a debtor owes is considered “canceled” debt. Debt that is forgiven is any debt that a creditor agrees to forgive (so that you no longer owe it), while discharged debt is debt for which you are no longer responsible under a bankruptcy case. To be clear, both forgiven and discharged debt is canceled debt.
In general, canceled debt is taxable, but there are clear exceptions.
Forgiven Debt is Taxed At Tax Time
Canceled debt that is forgiven by a creditor is usually taxable. How does this work? When a creditor agrees to forgive your debt, the creditor will consider the debt to be canceled. You will typically receive a Form 1099-C in the mail, a form that is also known as a “Cancellation of Debt” form. It will indicate the amount of debt canceled, and you will need to report that amount as income when you file your taxes, and you will need to pay tax on that amount.
Exceptions and Exclusions to Counting Canceled Debt as Income
The IRS identifies both exceptions to the rule and types of debt that can be excluded from your gross income. Exceptions include, for example, debts canceled as gifts or inheritances and debts canceled under specific student loan cancellation provisions. Under exclusions, the IRS specifically cites debt that has been canceled through a bankruptcy case.
Accordingly, discharged debt in a Chapter 7 or Chapter 13 case, which is debt canceled through bankruptcy, is not counted as part of a debtor’s income.
Contact a West Palm Beach Bankruptcy Lawyer
If you have questions about discharged debt, one of the experienced West Palm Beach bankruptcy attorneys at Kelley Kaplan & Eller can speak with you today.