Canceled Debt and your Tax Situation
In many cases, lenders forgive or cancel a taxpayer’s debt. And while this may seem like a benefit on the surface, it can lead to other issues such as brining on additional tax liability. If you, the debtor, are not aware of this, you may end up finding yourself owing the IRS additional money when you file your final return.
Current tax laws state that cancelled debt must be claimed as income by the debtor. As you can imagine, this greatly effects how much tax is paid, due to an increased income, and can also change the way that you deal with deductions.
If you find yourself in this position, you should be aware of the options for excluding this “extra income” from your tax return. There are three exclusions: one for bankruptcy, one for a case of insolvency, and one for mortgage debt. The mortgage exclusion is most commonly used, and for this reason should be understood by anybody in this position.
The Mortgage Forgiveness Debt Relief Act helps to provide tax relief to homeowners who lose their home to foreclosure, for example. This law allows individuals in this situation to exclude up to $2 million of certain debt. Of course, there are many criteria that must be met in order for a taxpayer to take advantage of this exclusion.
If canceled debt is staring you in the face and you do not know how to deal with it come tax time, hire a professional. As noted above, you may be able to take advantage of an exclusion that will help your tax situation. This is much better than being responsible for paying tax on additional income.
August 5th, 2008 at 12:04 pm
[…] other means. And, unfortunately, that sort of canceled debt is considered by tax laws to be income. The good news, reports Chris Bibey at the Tax Center, is the following: If you find yourself in this position, you should be aware of the options for excluding this […]