Debt Settlement, Insolvency, & Income Taxes

In November 27, 2009
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In January and February of every new year, I get numerous emails from people who have settled unsecured debts during the prior calendar year. They are surprised to find 1099-C forms in their mailboxes, which report to the IRS the forgiven debt balances as ordinary income. Many consumers are totally shocked to find they might owe taxes on cancelled debt balances. “How Read More …

263 Comments

  1. Hello My wife received a 1099c for 2395.00 we file joint return. I have been on short term and now on long term disability, and I’m currently filing for my social security disability. My wife subs at a school first is my income from the long term disability considered taxable or countable income taxable liability? I was told long term disability income is non-taxable sick pay income, and if that’s the case I should be able to file for insolvency, considering that my debt out ways my income. I don’t know if I’m wording this right, but I would love you input on this matter. Thanks.

    • Floyd, you are comparing apples and oranges, income against debt. The insolvency calculation is not based on income, but rather assets against liabilities just before the debt was canceled. The insolvency worksheet in IRS Pub. 4681 indicates that “interest in a pension plan” must be included as an asset. Tax professionals have generally interpreted this to mean private pensions through employers, but there hasn’t been any IRS cases/decisions (that I’m aware of) pertaining to Social Security income in general, or SS Disability Income in particular. You don’t indicate in your question whether your long term DI is private or from SS, but either way I’ve not seen anything in Pub. 4681 that would require inclusion of disability income as part of the insolvency calculation. I recommend you double-check this with the IRS help line, but you may or may not get a straight answer!

  2. If I receive a 1099-C as a result of a discharge of my student loans due to disability, do I fill out the insolvency worksheet based on the assets and liabilities that are in my name only, or do I include my husband’s assets and liabilities, as well? Does it depend on how we file our taxes? Thank you.

    • Carrie, if the 1099-C is only in your name, then the insolvency calculation is based on your share of assets and liabilities. If you order the $29 calculator product, the manual provides illustrations for various filing situations, etc.

  3. If I cosigned for a vehicle do I put the total bluebook value as my asset or do I only put half of its worth since I only cosigned for it? The vehicle is paid off. I also recieve ssi (disability) does that factor in too and how? I am going stop my ssi in about a month. Does the calculator take into account every single possible asset and liability possible?

    • Christopher, if you share title to an asset with another person who is not named on the 1099-C in question, then you only need to include your ownership share of that asset (which may or may not be 50% depending on your agreement with the other owner). Disability income is not a factor in the calculation. The calculator takes as many possibilities into account as I could include without making the manual 10,000 pages long. :-)

  4. Hi, I purchased the insolvency calculator and it works great it verified that I was indeed insolvent. My question is the IRS still wants proof can i copy the excel sheet and send that to them? Not sure what is appropriate proof for them. How would you handle this? Thank you

    • Phil, no, don’t send a copy of the Excel sheet. Instead, get a copy of the blank Insolvency Worksheet from IRS Publication 4681 and transfer your insolvency figures to that format. Depending on what they have specifically requested, I’d also probably include backup for the fair market value listed for major assets like real estate, etc.

      • Thank you again for your reply and the calculator.

  5. Does one have to include 529 account balances in the insolvency worksheet?

    • TaxGirl, yes, the insolvency worksheet, line 30, is for “interest in education accounts,” which means any ownership stake in a 529 or other education savings account. Sorry. :-)

  6. Thanks for your worksheet- got it figured out!
    My question is how to ( or whether to ) input info re: a leased car. It has no value to me as I will have to return it at lease end, yet I am liable for the remaining monthly payments on the lease??

    • Paul, there is nothing specific in the IRS instructions that discusses vehicle leases. However, my take is that it wouldn’t apply to the calculation, since it’s not an asset. To my mind, it’s no different from leasing a house or apartment rental, where you sign for 12 months. The rent is just an expense, therefore not relevant to the insolvency calculation. If you were to break the lease and get billed for the shortfall, that amount would then be considered as a debt. So unless you have actually surrendered the vehicle and have a lease deficiency obligation, it would make sense to simply ignore the vehicle lease for the purpose of calculating insolvency.

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