Debts Discharged in Bankruptcy are Not Taxable

Debts Discharged in Bankruptcy Are Not Taxable

Settled debts must be included in your income taxes

If you settle a debt for less than you owe, the balance canceled or forgiven is taxable income. You must report any cancelled or forgiven debts as part of your gross income on your income tax return. The creditor will send you an IRS Form 1099-C for Cancellation of Debt. You must report the taxable amount of a forgiven debt, in fact, even if the creditor does not send you a 1099-C.

Credit cards, personal loans, repossessions, foreclosures, short sales — any cancelled debt must be reported. Any debt (except tax debts) settled for less than the full balance can create enormous tax liabilities.

It’s important to determine how settling a debt will affect your gross income. Settling a debt versus discharging a debt in bankruptcy often has the effect of simply exchanging a private creditor for the IRS, which has vastly more powerful collection powers.

Debts discharged in bankruptcy are not taxable

Outside of bankruptcy, any forgiveness of debt is your taxable income. But debts discharged in bankruptcy are not taxable. Debts discharged in bankruptcy are tax-free.

The bankruptcy discharge is given special treatment in the tax code because Congress wanted bankruptcy debtors to get a fresh start on their finances. The bankruptcy discharge carve-out is contained in Internal Revenue Code Section 108.

Unlike settled debts, debts discharged in bankruptcy are non-taxable. So when it comes to taxes, filing a Chapter 7 bankruptcy or Chapter 13 bankruptcy will be almost always be preferable to debt settlement.

In some less common cases, discharged debts may reduce “tax attributes,” such as loss capital loss carry-forwards. In those cases, an IRS Form 982 should be filed. (For more information on this, see IRS Publication 4681). In general, though, those do not affect most bankruptcy filers. Lee Legal always recommends consultation with an accountant in the tax year following your bankruptcy discharge.

We help people file for bankruptcy

Debts discharged in bankruptcy are not taxable. Debts you settle outside of bankruptcy will be considered taxable income. If you want to understand your different bankruptcy options, seek out the personalized legal advice of the bankruptcy attorneys at Lee Legal.

Lee Legal is a debt relief agency. We help people file for relief under the Bankruptcy Code. To schedule a free financial analysis, call (202) 448-5136.

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About Brian V. Lee 513 Articles
Brian V. Lee provides bankruptcy, foreclosure defense, business turnaround, and litigation services to clients in the District of Columbia, Virginia, and Maryland. Brian was the Washington, D.C. state chair of the National Association of Consumer Bankruptcy Attorneys from 2016 to 2018.