Forgiveness of Debt

[Edsel]

I will soon be engaged in a prior year tax return for a year that included bankruptcy.

The general rule is debts cancelled under bankruptcy are not taxable.  However, there are a few 1099-Cs issued by credit card companies, which under normal circumstances will result in the reporting of taxable income.

Which, if any, are true:

• The govt will expect reporting of the debt cancellation as income even though taxpayer is bankrupt.
• The credit card companies can issue a 1099-C for that year if the specific debt is not listed with the debts covered with bankruptcy.
• Tax preparer should simply ignore the 1099-Cs

I'm aware that even reportable as taxable, the taxpayer can always resort to Form 982 and claim insolvency.  I just need to know how many hoops I'm going to have to jump through.

Thanks in advance - Edsel

[Lee B]

Pub 908 Bankruptcy Tax Guide & Pub 4681 Canceled Debts & Etc.

[Catherine]

3 hours ago, Edsel said:

Which, if any, are true:

First is kinda true.  Second is true.  Third is *dangerously* false!

Use Form 982 to show insolvency**.  What is really nasty is when the companies delay long enough on sending those 1099-Cs that the taxpayer is no longer insolvent, and then they have a tax problem.

 

**I always show corrections to income leaving $1 taxable income; that way the detail pages transmit.  That may not be the case with Form 982; it's been a while.  That may be a paper-file only form, in which case the IRS will indeed have all the detail pages.  Whether they notice/pay attention... that's another story!

[SaraEA]

No 1099c should be issued if the taxpayer was in bankruptcy.  "Should" of course doesn't mean it won't be issued.  If it is, just check the first box on Form 982 (Title 11 case).  Title 11 is the code section for bankruptcy, not to be confused with Chapter 11, which is a form of bankruptcy.

[Terry D EA]

Agree with both Catherine and SaraEA. Only thing to add, is your client insolvent? Also, get prepared, never ignore a 1099-C. I had a case several years ago where everything was checked and the IRS audited the return. Fortunately, my client had all of the paperwork from the bankruptcy that contained the schedule of creditors that were identified in the bankruptcy filing. This was a CH 7 bankruptcy and ended well. Just sayin.

[Max W]

After getting all the docs for filing a 982, I fill out the IRS worksheet  (pub 4681 p 6) and then have the client(s) sign it.  

[Jack from Ohio]

We have seen several clients, that used Form 982, and marked insolvency, that the IRS wants documentation of the insolvency.  For some clients, the debt was forgiven 2-3 years earlier.  Finding documentation for everything on the Insolvency worksheet, is nigh on to impossible.

[SaraEA]

If the taxpayer was in bankruptcy, you don't need to bother with insolvency.  Just check the box.  If 1099Cs were issued, you definitely have to report it.

[Edsel]

Great responses, all.  Thank you.

[Terry D EA]

SaraEA, your response makes perfect sense but remember we are dealing with the IRS. Ditto to what Jack said. I have had the same thing so just checking the box doesn't always work