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Neither a Lender or Borrower Be I

Neither a Lender or Borrower Be I

Lending and Borrowing Might Not Always Be the Best Options

This is a line from Hamlet, said by Polonius, in Scene III, Act I. Nevertheless, despite the wisdom of the advice, most people at some point are borrowers, and sometimes they do not pay their bills. Commercial creditors sometimes can be a generous and benevolent class of people, often forgiving debts. Now you have finally gotten the creditor off your back. You owed a large sum of money and you settled for pennies on the dollar. It’s January of the following year and you receive a document in the mail known as a 1099C. What is this? Unbeknownst to most people, a discharge of indebtedness is income. This is strange to most people because they think of income as money received, but in the context of the tax law, income is anything that results in an increase in net worth. Perhaps the creditor forgave $10 of debt. Your net worth increased by $10, since you have received the equivalent of $10 in income. It is considered to be a taxable event.

Exceptions

There are exceptions to this. The three major ones are indebtedness associated with a primary residence, a discharge of indebtedness in bankruptcy, and insolvency. Any indebtedness that is forgiven that is associated with your primary residence is not considered income. Likewise, if you file for bankruptcy and receive a discharge in Court, the amount discharged is not considered income. Lastly, if you are insolvent at the time you settle with a creditor, the amount settled is not considered income up to the extent of the insolvency.

This one can be tricky but here is an example of the calculation.

Example

A debtor has $160,000 in liabilities and $100,000 in assets.The debtor is insolvent to the extent of $60,000, meaning that if all assets were sold and all of the proceeds were used to pay debts, there would still remain $60,000 in unpaid liabilities and insolvency in the amount of $60,000. Now let’s say that a creditor forgives a $50,000 liability. None of this amount would be taxable since the amount forgiven is less than the insolvency of $60,000. Alternatively, let’s suppose that a taxpayer has $10,000 in assets and $9,000 in liabilities, and a creditor forgave a liability in the amount of $1,000. All of this amount would be taxable income since the taxpayer is not insolvent at the time of the forgiveness of debt.

Lastly, let’s now assume that the taxpayer has liabilities of $10,000, and assets of $7,000 so they are insolvent to the extent of $3,000. A creditor forgives a $5,000 debt. Since the taxpayer is insolvent to the extent of $3,000, this amount would not be included in income, but $2,000 would be includable.

IRS Form 982

IRS form 982 is the document that is attached to form 1040 and that addresses the cancellation of debt issues. This is an area where you should obtain professional advice. There is considerably more to the subject than is addressed in this brief article.

#IRSForm982 #Lender Borrower #TaxLiability #CrownBusinessBrokers #BradPalmer

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