Is Discharged Debt Really Income

4 February 2014
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4 February 2014, Comments Comments Off on Is Discharged Debt Really Income

Is Discharged Debt Really Income?

During these tough economic times, an individual struggling financially typically breathes a sigh of relief when a creditor decides to discharge an outstanding debt.  That relief continues until that individual realizes the IRS treats that discharged debt as income after they receive a 1099-C the following year, at which time the individual begins to panic.  The individual again feels helpless, except this time, they owe a debt to the federal government – or do they?

In some instances, Income from Discharge of Indebtedness (CODI) is not included in an individual’s gross income in the year in which the debt was discharged. The key exception, among others, is when the discharge occurs while the individual is insolvent.  Even then, though, the amount excluded from gross income is limited to the amount of the individual’s insolvency.

For example, an individual has a $2,000 outstanding credit card balance discharged.  The $2,000 discharged debt is now income to the individual in the year in which the debt was discharged.  Immediately prior to the discharge, the individual has the following liabilities – Mortgage – $60,000, Other liabilities – $4,000 – for total liabilities of $64,000, and the following assets – Home Value – $55,000, Personal Property – $5,000, Other – $2,000 – for total assets of $62,000.  As a result, the individual is insolvent by $2,000 ($64,000 liabilities – $62,000 assets).  Therefore, the CODI is not included in the individual’s gross income.

Cancelled Home Mortgage Debt

On the other hand, if the individual’s mortgage is only $59,000, they are insolvent by only $1,000 ($63,000 liabilities – $62,000 assets).  As a result, only $1,000 is excluded from gross income and the other $1,000 of discharged debt must be included. If the individual’s mortgage is only $55,000, then they are solvent ($59,000 liabilities – $62,000 assets = solvent) and must include the entire $2,000 discharged debt in income.

This is a simple example of when and when not CODI is included in an individual’s gross income.  The determination of whether CODI can be excluded from gross income is usually complicated and requires the assistance of a qualified tax professional.  If you find yourself in a similar position, please contact the Law Offices of Bryan S. Kessler, P.A. at phone (941) 786-1579 for a free consultation to discuss your tax issue.

 

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