New regulations about debt settlement taxation has triggered off several questions about debt settlement and income taxes. This article tries to cover the most important aspects of the same within its limited scope. Let us start off by explaining why settlement is taxable. This is because of the fact that once you go for settlement, you need to pay a certain amount of money to the creditor. This is the money that you save and it is considered as your income. Now, income being taxable, settlement becomes taxable. Hence, you need to pay taxes.
Question: Who informs the IRS about the settlement deal?
Answer: After the new regulations were implemented, the creditors are required to inform debt settlement deals to the IRS. The creditors issue 1099-C to the IRS which reports the details of the settlement deals taking place.
Question: What is 1099-C and what does IRS do with it?
Answer: 1099-C is the details of the debt settlement deals that the creditors agree to. It includes the information like customer name, forgiven debt etc. After IRS receives this from the creditor, it will forward the same to the debtor. The debtor will then have to account for the same in the IT return. If the debtor fails to do so, the IRS will file Federal Tax Lien and take steps against the debtor in form of penalties and interests.
Question: Can settlement taxation be avoided?
Answer: Yes, it can be avoided under various situations. In case the debtor can prove insolvency during settlement, it becomes non-taxable. The forgiven debt is non-taxable if the debtors indebtedness is due to any loss in a real property business or if the forgiveness was an outcome of a bankruptcy proceeding. Also, if the forgiveness is considered as a gift, the debt settlement taxation can be avoided.
Question: How to report insolvency to the IRS?
Answer: By filling the form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness issued by IRS along with tax return. The debtor can also alternately attach a letter with the detailed calculation of the total debts and the total assets during settlement along with the tax return.
Question: Is there any specific amount of forgiven debt that is taxable or any amount forgiven is taxable?
Answer: If the forgiven debt amount is greater than $600, it becomes taxable!
Source by Percy Wilson