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Foregiveness of Debt Income and Taxes

Posted by attorney Gerard O'Brien

Times are hard and many of us have negotiated reductions in the debt we owe which is secured by our homes and even unsecured credit card debt, memberships, dues, purchase prices on already received property. We have done this to survive on reduced incomes either from slow business , loss of job, loss of investment, large medical bills, etc.

The relief this reduction in debt provides is emotionally, intellectually and physically is astounding, you sleep better, you have energy again and the future seems bright. Then the 1099C's start arriving and they show all of the debt discharged as income to you. There is a flicker in your outlook, am I going to fall back into the "Pit?"

CODI is income to you, because you do not have earn or take from your savings the money to pay the debt. It is therefore taxed as regular income,so if you are going to have substantial foregiveness of debt income care should be taken to determine if it is possible or wise split the CODI over a number of years. Yes! Hang on until January and possibly the following January for as much debt as you don't want to pay taxes on this year.

The forgiven debt is also known as Cancelation of Debt Income (CODI) and this CODI tax can be reduced dollar for dollar under five situations set fourth in IRC 108 (a) (1).

CODI is excluded from gross income if you discharge the debt in a USC Title 11action, that is a bankruptcy. Discharges are available in Chapter 13, Chapter 7 and certain Chapter 11 cases.

Bankruptcy is the best way to get a clean start without the debt and the accompanying taxes. In 2005 the Bankruptcy code was rewritten in a way that greatly favors creditors rights over those of the debtor, but the process is still useful and well used. Chapter 7 is a straight liquidation of debt and non-exempt property. Chapter 13 Called a "Bill Payer" or "Wage Earner," sometimes provides the most complete relief from debt, and If an individual files a Chapter 11 because he does not fit within the dollar liitations of Chapter 13 may also be discharged

The next way to get rid of CODI is to show that you are insolvent and show that your insolvency is made up of assets worth X $ and debts worth X $ +. That plus amount is the amount of your insolvency and that amount can be applied dollar for dollar against your CODI and its accompanying taxes.

As an example if you have $300,000 dollars of assets and 500,000.00 of debt you are insolvent by $200,000.00 and that is how much forgiveness of debt income can be excluded from gross income

The stigma of bankruptcy has never been lower due to economic conditions; California having 12.5% unemployment, and the great number of people who have been forced through no fault of their own to file.

Filing Bankruptcy is a major descission and should not be entered into lightly. One reason is you can generally speaking onlyobtain a discharge in Bankruptcy every 8 years in Chapter 7 and every 6 years in Chapter 13.

Resolving your debt and tax issues outside of filing a bankruptcy is called an "Out-of-court Work Out, if such an arrangement can be made to work they work they can save you money, time, the formality of a court procedure, and provide you with greater flexibility,but they also produce less assurance that a debt has really gone away.

COMING SOON IRC 108 (b) "past failures may pay for present and future failure

Additional resources provided by the author

Internal Revenue Code
IRS Publications 908 Bankruptcy Tax Guide
IRS Publication 946 How to Depreciate Property
IRS Publication 4681 Canceled Debts ... and Individuals
IRC 38 39 108 1017
Final Regs for 108 and 1017

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