cancellation of debt tax Archives - Northern California Bankruptcy Lawyer

Five Tax Tips For Two Cents

Tax season approaches.

There’s a surprising degree of overlap between bankruptcy and tax I’ve found over three decades as a bankruptcy lawyer.

Here’s my two cents on what I know about taxes. It’s not a lot, but what I know is both simple and critical.

File those tax returns

Lots of folks who end up in my office discussing bankruptcy held off filing their returns because they figured they couldn’t pay the tax that would be due.

Bad decision.

Without a return, taxes never die

The IRS will not descend on you the week after you file a return with tax due but no check. They’re still opening envelops.

But filing a return gets all kinds of time periods running that may benefit you: the 3 years til the taxes are dischargeable in bankruptcy; the 10 years til the tax collection statute runs.

Whatever you do, don’t let the IRS file a tax return for you.

Don’t pay tax on discharged debt

If your debts were discharged in bankruptcy last year, that discharge has no tax consequences.

The Internal Revenue Code specifically excludes from taxable income any debts forgiven in bankruptcy.

Cancellation of debt is tax free

You may get a 1099 reporting the cancelled debt. The creditor whose debt is forgiven is required to do so.

It’s up to you to assert that there’s an exception to tax. And there’s an IRS form to rebut any tax consequences. Get it and file it.

Claim deductions for Chapter 13 payments

If you’re in a Chapter 13 that catches up arrearages on real property loans, claim those payments as deductions of your own. Just because the trustee writes the check, it’s still you paying the mortgage interest in that payment.

How to find and claim the deduction

The concept here goes beyond mortgage interest. If the expense was deductible had you written the check, it’s deductible if the trustee pays it.

Get the trustee’s disbursement records in your case from the trustee’s web site and get to deducting.

If you owe tax, fix your withholding

The return to be filed this spring can tell you if you are withholding enough money to pay your taxes.

If there’s a big number on the bottom line of the return for last year, and this year looks similar, increase your withholding now.

What Goldilocks knew about taxes

And if you think you can’t pay taxes as you go and support the rest of your living expenses, you need to look hard at the big picture.

It’s generally a poor decision to short the feds so you can pay AmEx or Visa.

Amend old returns if you missed something

If you missed a deduction or otherwise overpaid your taxes in a previous year, you have only three years to amend that return and claim a refund.

Time running out to claim prior year tax breaks

Lower income families often miss the fact that they get a tax credit (that’s real money, not just a deduction) under the Earned Income Tax Credit. Find out if you are eligible.

Discharging taxes in bankruptcy

The tax filing extension can be dangerous

Wiping out tax liens

Long Term Tax Savings When You File Bankruptcy Rather Than Settle Debts

By Cathy Moran

Settle your debts outside of bankruptcy and you may be bitten by taxes you didn’t expect years later.

Everyone I talk to would rather cut a deal with their creditors than file bankruptcy. It’s universal.

But here’s the killer reason why bankruptcy alone protects homeowners from a unexpected tax consequence down the road.

Debt forgiven outside of bankruptcy gets deducted from the basis of your home. Result: more potentially taxable capital gains on sale.

It works like this.

Tax treatment of cancelled debt

Debt forgiven in bankruptcy or while insolvent gets an exception from the standard tax rule that cancelled debt is taxable as income. IRC 108.

But that tax benefit comes with a delayed cost. The amount of the debt forgiven is deducted from the basis of your assets.

So if the tax basis in your home was $200,000 and the debt that was discharged or settled was $200,000, you end up with a house with zero basis.

Sell that house and every dollar you receive is capital gain. Ouch!

Special tax rule for homes in bankruptcy

But wait! Wait! There’s an exception to the reduction of basis rule that shields your principal residence from reduction in basis. But that exemption applies only if your debt was cancelled in bankruptcy and you claimed your home as exempt.

So, the basis in your home is not reduced if the debt was forgiven in bankruptcy, rather than an out-of-court settlement, and you claimed an exemption. IRC 1017(c),

So, when you consider your alternatives for getting yourself out of debt, homeowners need to look beyond this year’s tax return to the point at which they may sell their house. Every dollar in basis excludes that dollar from being taxed as capital gain.

How tax exception for forgiven debt works

The ugly truth about debt settlement

How bankruptcy deals with taxes

You've arrived at the Bankruptcy Soapbox, a resource of bankruptcy information and consumer law.

Soapbox is a companion site to Bankruptcy in Brief, where I try to be largely explanatory and even handed (Note I said "try").

Here, I allow myself to tell stories and express strong opinions on how I think law should work for the consumer and small businesses when it comes to debt.

Moran Law Group
Bankruptcy specialists for individuals and small businesses in the San Francisco Bay Area