Two weeks ago, I wrote that there are certain situations which permit the exclusion from Gross Income on a Taxpayer’s tax return, when they are the recipients of debt forgiveness that would typically be taxed. One of the options that permitted exclusion was for debt cancelled during insolvency. Today we’ll discuss what insolvency is and the impact of insolvency on the Exclusion from income of forgiven debt.
If a debt was forgiven under the other exceptions that were outlined in my article two weeks ago, insolvency will not be required. Those exception included:
- Debt canceled in a Title 11 bankruptcy case.
- Cancellation of qualified farm indebtedness.
- Cancellation of qualified real property business indebtedness.
- Cancellation of qualified principal residence indebtedness that is discharged subject to an arrangement that is entered into and evidenced in writing before January 1, 2018
If these are not options, the taxpayer may still qualify under Insolvency.
What is Insolvency?
A taxpayer is insolvent when the liabilities of the taxpayer (debts of the taxpayer) exceed the assets of the taxpayers. Assets would include cash, investments, the Fair Market value of Real Estate, vehicles, furniture and other items of value owned by the Taxpayer. Liabilities include credit cards, mortgage and auto loans, and other loans and amounts owed to 3rd parties. The Taxpayer will add up all their assets and all their liabilities. If assets are greater than liabilities, the taxpayer is not insolvent and if liabilities exceed assets, the taxpayer is insolvent. The Taxpayer should be prepared to support their calculation to the IRS when making the exlusion.
How Much Can Be Excluded?
First, the calculation should be on the date of forgiveness. Do not use your current assets and liabilities to determine the insolvency on debt forgiveness. Insolvency for Debt forgiveness is not an all or none proposition. Normally, the taxpayer’s exclusion will be to the extent of Insolvency.
Example 1
Debt forgiven is $25,000 and liabilities exceed assets (insolvency calculation) by $50,000 on the date of the debt forgiveness. In this case, the full amount of debt forgiveness can be excluded.
Example 2
Debt forgiven is $75,000 and liabilities exceed assets (insolvency calculation) by $50,000 on the date of the debt forgiveness. In this case, $50,000, the amount that the taxpayer was insolvent, can be excluded.
Do You Need Help?
If you’ve received a Form 1099-C that you believe may be excludable from income and need assistance with that problem, or if you need help with any other IRS or tax matter, we’d like to help. Please give me a call at (972) 821-1991 or email me at [email protected].
