Many debtors may have reached an agreement with their lender to settle their debts in 2012. The tax implications for doing so, depend largely on what type of debt was relieved and the financial state of the debtor. Did you have debt relieved in 2012?
Did you receive a 1099-C form?
This form is sent by the lender to each debtor and the IRS in which $600 or more of the debt owed to the lender was cancelled. Since the IRS treats the cancellation of debt as income, in most cases the amount discharged must be reported as income on the debtor’s tax return. You likely haven’t received this form yet as the deadline to send 1099 is January 31st, 2103. However, if you had debts relieved during the year, you should be expecting this form from the lender.
Is debt relieved through a foreclosure or short sale taxable?
No, thanks to the Mortgage Relief Act, borrowers can exclude up to $2 million of forgiven debt and $1 million if married filing separately on their primary residences (second homes and investment properties still do not apply). The only way to exclude debts on second homes or investment properties would be if the borrower filed for bankruptcy and could provide support to show insolvency. In this case, you would report the 1099-C amount of discharged debt on Schedule D of your Form 1040. On the next line of Schedule D, you will deduct the same amount, and indicate that the debt was discharged in bankruptcy. You must cite the appropriate bankruptcy case number on the schedule to support your claim.
What about discharged credit card debt?
Unfortunately, discharged credit card debt is subject to federal and state taxes. The amount of taxes you will pay will depend on your marginal tax bracket. For instance, if you’re single and your adjusted gross income is $50,000, your marginal tax rate would be 25% for the 2012 tax year. Therefore, any credit card debt relieved would be subject to a 25% federal tax rate plus any state taxes. Again, the only way to exclude the debt relief from your income, would be through a bankruptcy ruling that shows insolvency.
More tax questions? Browse answers or ask your tax questions online.
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