|
IRS Letter - Cancellation of Debt
|
The IRS computer system is
working over-time generating thousands of letters to unsuspecting
taxpayers proposing a tax assessment on "Cancellation of Debt".
The root of the problem stems
from lenders, especially credit card issuers not informing the
taxpayer that when they settle a debt for less than the full amount,
the company will issue a 1099-C form. The 1099-C form tells the IRS
that they loaned you money which was forgiven and therefore should
be treated as taxable income to you.
Most often, the debt that was
relieved represented accrued interest, finance charges and late
payment penalties more so than principle.
|
|
What is "imputed" income as a
result of debt discharge and what can I do about it?
Many
financially distressed individuals who lose their homes to
foreclosure or cannot pay off their car loans, credit card balances,
student loans, or medical bills do not realize that their
delinquency may increase their tax liabilities. If a creditor/lender
writes off a debt, the tax code generally treats the amount of the
canceled debt as taxable income to the debtor. Congress created
a number of exclusions or exceptions, including an exception for “insolvency” and
a recently enacted exclusion to help some (but not all) homeowners
whose mortgage debt is canceled when their house is foreclosed on
and sold, or whose loan balances are reduced as part of a mortgage
loan modification. However, taxpayers do not automatically receive the benefit of
these exceptions. A taxpayer must file Form 982,
Reduction of Tax Attributes Due to Discharge of Indebtedness (and
Section 1082 Basis Adjustment), to claim an exclusion.
IRS data shows that approximately two million
1099-C forms (Cancellation of Debt)
are issued to taxpayers and the IRS each year reporting canceled debts. In this
economy, the number of taxpayers defaulting on credit card bills,
car loans, home mortgages and other debts is rising at a rapid rate.
What can I do if I settled a
credit card debt and receive a letter from the IRS?
The first thing you should do is
contact a tax professional: EA, CPA or attorney. There are several
specific situations that will remedy the problem simply with a
letter of explanation or filing of a form. Don't think that you have
to go to Tax Court and spend thousands of dollars (that rarely is
the case).
If you filed bankruptcy, you can
send a letter of response referencing your bankruptcy case number
and attach a copy of just the first page of the bankruptcy petition.
This will make the IRS go away quickly.
If you did not file bankruptcy,
there are still other exceptions available to you. A letter to the
IRS stating that you were insolvent at the time will work if you
attach a one page list of your assets and liabilities showing that
your liabilities were greater than your assets at the time.
What can I do if I had an
automobile repossessed and receive an IRS letter?
The lending institution will
issue a 1099-C quite often for the difference between what you owed
at the time of repossession and what they sold the vehicle for after
they repossessed it. This is truly unfair to the poor taxpayer that
originally agreed to pay too much for a vehicle because it was the
only option available to them at the time, i.e., bad credit.
You may actually have a loss on
the transaction. Whether that loss is deductible or not depends on
whether the vehicle was used for personal or business purposes. In
the eyes of the IRS, it is like you sold the vehicle for whatever
amount of debt you were relieved of.
This can be resolved either way.
What if I had my home foreclosed
and receive an IRS letter?
Again, the lender may issue a
1099-C showing how much debt was cancelled and what they sold the
home for after the foreclosure. The IRS views this as if you sold
the home for whatever amount of debt was cancelled with the
foreclosure. This can be remedied and in most cases you will owe
nothing in the end.
What can I do if I co-signed with
someone on a loan and they default?
I recently saw a case where the
taxpayer had co-signed on a loan (actually a credit card) as
"guarantor" with a corporation owned by his son. The corporation and
the son filed bankruptcy. Then the lender came after the father who
had co-signed. The father settled the debt and the credit card
issuer turned in a 1099-C on the father.
The problem was, the issuer did
not inform the taxpayer that they were going to issue a 1099-C and
did not mail a copy of the 1099-C to the taxpayer. Two years after
filing his personal tax return, the taxpayer received an IRS letter
stating that he owed several thousand dollars!
The problem was compounded
because after the IRS added the 1099-C income to his tax return it
caused him to owe additional taxes on more of his Social Security
benefits. Talk about unfair tax treatment!
One of the exceptions that will
get you out of paying tax on this phantom income is if you can prove
that you could have taken a tax deduction for the debt if you had
paid the debt rather than it being cancelled.
This article was written by:
Feel free to copy or reproduce
this article as long as you keep the author's name and link to his
website as stated.
|
|
