CH-7, Cancelation of Debt notice, and Taxes

[LadyInTheRed]

I had to claim the 1099-C because I have not filed BK yet, and I had to get my taxes done for 2010 prior to filing

Do you mean you included all of the forgiven debt as income? The following section of Publication 4681 may be applicable to you:

Insolvency

Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include:

* The entire amount of recourse debts,
* The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt, and
* The amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the property subject to the debt is forgiven.

You can use the worksheet on page 6 to help calculate the extent that you were insolvent immediately before the cancellation.

http://www.irs.gov/publications/p4681/ch01.html#en_US_publink1000244090

If you were insolvent when the debt was forgiven and you included the forgiven debt as income on your return, you should amend your return. You attach form 982 and check a different box than if the debt was discharged in BK.

ETA: If the debt was for a mortgage on your home, read about the exemption for Qualified Personal Residence Indebtedness, another box on form 982.

[ruttie]

I had to claim the 1099-C because I have not filed BK yet, and I had to get my taxes done for 2010 prior to filing

[LadyInTheRed]

I thought we would have to file a 982 as well but after meeting with our CPA I don’t recall him approaching it this way. I believe he showed the phantom income in the filing then deducted it as an expense so it would not be taxed. He is well aware that we filed for BK. He seems to know his stuff and I feel confident that he is doing it correctly. If you have any doubt hire a good CPA to make sure it is completed correctly. The money you save in taxes will outweigh the money spent on the CPA (not to mention that expenditure will be tax deductible next year).

Your CPA may have done it that way and it worked out the same as far as calculating your income and tax, but I don't believe he did it correctly. This could result in the need for further explanation to the IRS, including a possible amendment of the return. It could also never come up at all. The method won't work for somebody who does not itemize deductions on Schedule A.

I agree that anyone who has any doubts should hire a CPA. But, if you normally prepare your own returns, before you spend money to hire a CPA only because you received a 1099c, you may be able to get rid of any doubt by reading the IRS instructions.

Instruction for 1040 are at http://www.irs.gov/pub/irs-pdf/i1040gi.pdf. On page 10, it says to see publication 4681 to determine where to report canceled debt from the 1099c. The following is from the introduction to the canceled debts section of Publication 4681:

There are several exceptions and exclusions that may result in part or all of a canceled debt being nontaxable. See Exceptions and Exclusions, later. You must report any taxable cancelled debt as ordinary income on:

* Form 1040 or Form 1040NR, line 21, if the debt is a nonbusiness debt;
* Schedule C (Form 1040), line 6 (or Schedule C-EZ (Form 1040), line 1), if the debt is related to a nonfarm sole proprietorship;
* Schedule E (Form 1040), line 3, if the debt is related to nonfarm rental of real property;
* Form 4835, line 6, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or
* Schedule F (Form 1040), line 10, if the debt is farm debt and you are a farmer.

Form 1099-C. If an applicable financial entity cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2. Unless you meet one of the exceptions or exclusions discussed later, this canceled debt is ordinary income and must be reported on the appropriate form shown above.

[For purposes of this explanation, I'm just going to assume we're dealing with nonbusiness debt]

So, taxable canceled debt is reported on line 21 of form 1040. But, if there is an exception or exclusion, the canceled debt is not taxable and therefore does not get entered on line 21.

Under exclusions, Pub 4681 says:

If a canceled debt is excluded from your income, that means it is nontaxable.

Just below that, under bankruptcy, it says:

How to report the bankruptcy exclusion. To show that your debt was canceled in a bankruptcy case and is excluded from income, attach Form 982 to your federal income tax return and check the box on line 1a. Lines 1b through 1f do not apply to a cancellation that occurs in a title 11 bankruptcy case. Enter the total amount of debt canceled in your title 11 bankruptcy case on line 2. You must also reduce your tax attributes in Part II of Form 982 as explained under Reduction of Tax Attributes, later.

[I believe the reduction of tax attributes has to do with basis in assets that forgiven debt is related to. If you think that applies to you, click on the link in the publication and read the instructions for form 982 so you can figure out how to complete part II of the form. In fact, even if you don't think it applies to you, read the instructs to make sure it doesn't.]

If the amount on line 2 of form 982 is equal to the amount of forgiven debt on the 1099C, there is no taxable income to report on line 21 of form 1040.

[If you look at Schedule A and it's instructions (and the rest of form 1040), you will see that if you include forgiven debt as taxable income, there is really no appropriate place for a deduction for forgiven debt discharged in BK].

[angles]

I thought we would have to file a 982 as well but after meeting with our CPA I don’t recall him approaching it this way. I believe he showed the phantom income in the filing then deducted it as an expense so it would not be taxed. He is well aware that we filed for BK. He seems to know his stuff and I feel confident that he is doing it correctly. If you have any doubt hire a good CPA to make sure it is completed correctly. The money you save in taxes will outweigh the money spent on the CPA (not to mention that expenditure will be tax deductible next year).

[Alumofuf]

I am filing thru Taxact.com, the free version and it is letting me add the form 982 to the return. Just in case someone may find this useful....

[LadyInTheRed]

Now that I have more time than I did when I posted earlier, I looked it up. It's form 982. Turbotax will tell you it it can't help you with that form. But, it doesn't affect any other part of your return. Just download it from the irs website, fill it out and attach it to your return. You just won't be able to file your return electronically.

[nevada]

1099c

hi,

thank you for the reply. you are correct in that it is a 1099-C. I am using turbo tax to do my taxes. might have been a bad idea for this years go round as i am not seeing the additional form mentioned. i will dig around around as suggested.

thanks!

[LadyInTheRed]

You must mean 1099-C. Know you do not have to pay taxes on debt discharged in BK. You just need to attach an extra form to your tax return. I can't think of the form number right now, but you'll find it if you search on this board for "1099-C" and maybe "1099C". I posted yesterday or the day before to a question about amending a return that mentions the form.

[nevada]

Im a bit confused on whether i have to put in the info for a "1098-C cancellation of Debt" on my 2010 tax return. I still have to pay taxes on debt that was removed by my BK?