Reduced Or Cancelled Debt is Part of Your Taxable Income

For anyone who has ever been in a serious debt, getting the credit card company or any other creditors to reduce or even cancel your debt is like the best thing that could ever happen to you and your family. You record will be cleaned, and you no longer will have the burden of all that debt hanging on your shoulders. Often, people don't realize that if they're not careful, and do not prepare properly, then they are actually setting themselves up for a potential IRS trouble. The fact is, the IRS considers the reduced or cancelled debt as taxable income, thus, you will be required to pay taxes on this. So the next time you avail of this benefit, make certain that you understand that you will be partly indebted to the IRS for this. That is the general guideline concerning this matter.

A number of years ago, getting a loan or having credit card applications approved was relatively easy. Because of this, many people become impulsive buyers and irrational spenders. People forget to consider their financial capacity and just went on buying off things.

Banks are aware that they do not have the legal authority to send people to jail just because of a massive debt. Hence, in certain situations, they hire private agencies to collect from delinquent borrowers. The amount that shall be paid to these agencies will depend upon the collections. Let's now go back to the topic on reduced debts. Take for example the case of someone whose debt of $20,000 was reduced to $10,000 as the other half was forgiven. In this case, you will be required to pay taxes on $10,000 as that will form part of your income.

You cannot evade paying taxes on a tax reduction as a copy of your Form 1099-C will be forwarded by your creditors to the IRS. The IRS considers this as "other income", which gets reported on line 21 of tax Form 1040. The problem gets magnified because you'll now be required to pay a huge percentage of the $10,000 to the IRS. This is aside from being required to pay for your regular and state taxes. This case is a good example of why first and foremost, there is a need to understand the effects of a reduced debt. Your debts to your creditors maybe eliminated, but these are transferred to the IRS. One thing remains: you're the still the one who will pay for those debts.

Unlike regular creditors, the government can send you to jail if you consistently don't settle your taxes. It's fortunate, however, that certain measures are available to help those who are in need. For example, if the creditor of your home forgave $100,000 from your total debt of $200,000, naturally, $100,000 will be reported to the IRS as part of your "other income." With such an amount of money to pay taxes on, it is rather likely that you will be bumping into an IRS trouble. Fortunately in 2007, Congress has made a law specifying that tax reductions amounting to a maximum of $2 million and attached to your primary residence are to be excluded from your 2007, 2008 and 2009 tax returns. In our scenario above, you will be exempted from paying taxes on the tax reduction because of this new law. On another light, the IRS also provides a number of remedies for tax payments on reduced debt. Prior to availing any of these, make sure that you have asked assistance from a tax attorney or a CPA.

Darrin T. Mish is a Nationally recognized Attorney whose practice focuses on representing clients across the United States with IRS Problems. He is AV rated by Martindale-Hubbel and is a member of the American Society of IRS Problem Solvers and the Tax Freedom Institute. He has been honored by a listing in Martindale-Hubbel's Bar Register of Preeminent Lawyers. His passion is providing IRS help to taxpayers with both individual and payroll tax problems. He teaches attorneys, CPAs and Enrolled Agents in the finer aspects of IRS representation all around the United States. He can be reached at his website at http://www.getIRShelp.com