Do you pay tax on the amount discharged in your Arizona Bankruptcy?

No.  Although outside of bankruptcy you can be taxed on the amount of debt that one of your creditor’s discharges for you, inside of bankruptcy the IRS does not consider your discharge of debt as income.

But wait a minute! You may be thinking: How can a discharge of debt be considered income? Well, the reason that cancellation of your debt is consider income is simple. The IRS rule that makes a discharge of debt “income” is designed to prevent people from defrauding the IRS. For example, say you do a job from someone and they owe you $5000. Instead of paying you they could give you a “loan” and then just discharge the loan. This could happen because a loan is not considered income when you take it out.

Although discharge of your debt in bankruptcy is not considered income, many creditors are required to send you a form called a 1099-C. If you have discharged you debt in bankruptcy and still get one of these forms the IRS has provided you with a simple fix. Filling out a form 982. Your Tucson bankruptcy attorney will be able to help you fill out this form and make sure you don’t have any tax issues. Rest assured if you get a bankruptcy discharge that amount will not be included as income for the tax year.

But what if I don’t go into bankruptcy and just have the debt cancelled?

If you have any portion of your debt cancelled, by any one of your creditors, you may be surprised to find that this money may be considered “income” by the IRS for the taxable year. For example, say you own your credit card company $20,000 and use a debt reduction company to help you reduce that debt to $10,000. Essentially the credit card company has agreed to “cancel” $10,000 of your debt. What you may not know is that this $10,000 must be included as “income” in your tax return. Although it sounds somewhat complicated the basic thing you need to know is this: If you owe money to a creditor, and they decide to “forgive” some of this debt, the amount of debt they forgive is included as “income” on your tax return for that year.

If this is the case you will be receiving a form 1099-C from the creditor who cancelled your debt. If your creditor canceled at least $600 of your original debt they are required by law to file 1099-C forms with the IRS and send you a notice in the mail. DO NOT THROW AWAY THIS FORM. You must include the 1099-C form with your tax return. Failure to do this could put you at risk for penalties, fines and audits from the IRS. It is important to take these forms to a tax preparer or contact your Arizona attorney.

Finally, under certain circumstances you may be able to convince your creditor not file the 1099-C form. Some creditors will let you let you cancel your debt by considering it “paid in full” even if you haven’t done that. If they do this you should ask them not to report the remaining amount of unpaid debt to the IRS. Many creditors will be willing not to report the remaining debt. However, your creditor is not required to follow your request.

For more information about filing bankruptcy in Arizona, or debt reduction options in Arizona, contact a Tucson bankruptcy attorney today.