SPRINGFIELD, Mass. (Mass Appeal) – Do you know what potential tax concerns are associated with debt? Attorney Susan Mielnikowski from the Law Offices of Cooley Shrair in Springfield shared more.
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With the recent downturn in the economy, it was common to have more debt than a person could support. Many have been able to reduce or cancel their debts, but I understand there are potential tax concerns with this?
Yes. In general, if a debt for which you are responsible is canceled, forgiven or discharged, whether by way of a negotiation or a foreclosure, the cancelled amount must be reported as ordinary income, unless you meet an exception or exclusion.
For example, if you have a credit card with a $10,000 balance, and are able to negotiate with the credit card company to accept a payment of $4,000 in satisfaction of the debt, the $6,000 in debt that is forgiven must be reported as ordinary income for tax purposes. This also applies for a home that is sold in a short sale, where your mortgage lender agrees to accept a lesser amount in order to allow you to sell your home, or a foreclosure, where the bank takes the home is satisfaction of the debt. Any cancelation of debt should prompt a consideration of whether it will create an income tax.
What are the exceptions or exclusions?
Each situation must be reviewed individually. There is a distinction between an exception, and an exclusion, and understanding what category your facts may fit into could have impacts on your overall income tax situation. However, one example of an exception is debt canceled as a gift or inheritance (for example, a parent forgiving a loan to a child in their Will). A common exclusion is cancelation of qualified personal residence indebtedness, such as in a foreclosure.
So before someone makes a deal to cancel debt, or is in a situation that could result in cancelled debt, what do you suggest?
I suggest consulting with a tax professional who can give you guidance as to your options, and even if there is no way to avoid having the income includable, at least being aware of it to avoid an unexpected tax liability.
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