Debt has become inevitable in many lives in the modern age. In fortuitous circumstances and probably after jumping through many legal hoops, debts may be cancelled and loans forgiven by a lender. However, even though you may be freed from those debts by a lender, that cancelled debt may still be taxable. Most people don’t know, but they may still end up having to pay taxes related to those cancelled debts since the balance of those cancelled debts are treated like income for tax purposes.
Cancelled debts
Say for example, a lender compromises with you regarding an outstanding personal loan of $8,000. They agree with you that if you pay off $4,000 of that debt, they’ll accept it in satisfaction of the loan. The remaining $4,000 of that loan now gets treated as part of your gross income for annual tax filing.
Bankruptcy, Gifts, and Other Exceptions
Of course, there are exceptions to keep in mind. Generally, debts cancelled in relation to a bankruptcy are excluded and not taxable on a person’s income. Debts canceled as a gift or inheritance are also not taxable. Cancelled qualified debts in real property and farming may also be excluded from being taxable.
1099-C
If you have any canceled debts, you should receive a 1099-C form from an applicable entity, such as a bank or a government entity like FDIC. Besides the usual identifying information, the form has an “Identifiable Event Code” section where a letter denoting what kind of event the canceled debt is related to. For example, “A” would be for Bankruptcy, “F” would be for By Agreement. You’ll need this document with your individual filing.
The taxability of cancelled debts may not be something commonly known. Having a knowledgeable accounting support team can help you and your business swerve around these potential financial potholes. MiklosCPA is a California-based accounting firm that helps many clients with their accounting and tax needs. Learn more of how our services can your business reach its growth potential! Contact us, and also follow our social media for more future “good-to-know” posts.