Some of my clients try to hide their break for financial freedom from friends and neighbors.
Others are worried about their boss finding out.
Occasionally, someone will try to keep it from their mate.
But trying to hide his bankruptcy nearly cost one client $103,000!
Because he hid his bankruptcy filing from his accountant.
It’s all about the tax
When my client got his bankruptcy discharge, stripping off the junior lien on his house, the mortgage lender dutifully sent him a form 1099.
The tax form correctly reported that $288,000 of debt had been forgiven in the last tax year.
And my client delivered the 1099 to his tax preparer, who in turn said,
That will be an extra $103,000 in tax, due and payable on April 15th.
Only, once the tax preparer got the news about the bankruptcy filing, it wasn’t so.
Debt forgiven in bankruptcy isn’t taxable
A discharge in bankruptcy is the first exception to the standard tax rule that debt that is forgiven is treated as if it were cash income.
When the discharge occurs by reason of a bankruptcy case, the discharged debt is not taxable income.
Responsibility for connecting the dots on discharged debt falls to the debtor/taxpayer. The creditor whose debt has become worthless is obligated only to report to the IRS that the debt has been forgiven, as a matter of law.
The creditor generates a 1099 form, without comment on the circumstances.
The taxpayer is charged with filing the form that says, in IRS speak, “yes, but….”
Yes, the debt was discharged; but, no, the discharge didn’t increase my taxable income.
The “because” is the discharge in bankruptcy.
Accountant needs to know about discharge
Had my client told his tax preparer upfront about the bankruptcy, he could have avoided several hours of intense stress.
Retired and living with family, he probably doesn’t have $103,000 in net worth, much less that kind of money sitting around for Uncle Sam.
I’m an advocate for openness about bankruptcy. It’s not shameful nor the mark of failure.
If everyone who had filed bankruptcy admitted it, those who are now struggling with the decision to file wouldn’t feel like they are the only ones who ever chose bankruptcy rather than perpetual debt.
But regardless of whether you’re willing to share with others the fact you’ve filed bankruptcy and gotten a fresh start or not, share the facts with your CPA.
It will save you money.
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