Caution! If You Are Not Careful You May Have to Pay Taxes on Your Cancelled or Reduced Loans
By: Seomul Evans
Submitted: 2010-04-30 08:52:13 | Word Count: 651
If you are neck deep in debt and are constantly trying to make ends meet, you may get the biggest reprieve if the bank or lending institution that you are dealing with agrees to cancel or reduce your debts. Now, don t be under the impression that this is going to be easy; however, it is not impossible either. Getting your debts cancelled or reduced is a wonderful way to start on clean slate; all your records will be cleaned and you will be free from the pesky monthly payments that were giving you sleepless nights. But if you are not careful, this boon may turn into a curse faster than you know. You may have to pay taxes on any debt reduction or cancellation if you don t prepare meticulously for the procedure.
For those of you who did not know his, the IRS does consider all cancelled and reduced debts taxable since it is considered to be an income. So before you start rejoicing, you have to understand that even though you may not have to pay the bank you will certainly have to settle your IRS accounts.
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Given the current economic turmoil, the ease with which people could get back loans and credit card debt a few years ago and the mounting uncontrolled and often irrational spending has led to many people finding themselves in debt hell. Now even though your bank cannot initiate a criminal proceeding against you, they can certainly foreclose any collateral or may even initiate civil proceedings to recover their dues. Often they employ the services of private debt collection agencies. These firms will charge the bank a percentage of their collections so they will be inclined to extract the maximum amount. However, in case your debt is $ 20,000 depending on how plausible your situation is, you can get a reduction of almost 50 . However even though you will only owe the bank $10,000 you will still be required to pay taxes on the $ 10,000 reduction that you received.
You cannot escape these taxes or withhold the information of a debt reduction or cancellation from the IRS because your creditor will furnish this information through Form 1099 C. According to the IRS, this is deemed as other income and you will find it mentioned on line 21 of your tax form 1040. The issue is that a large percentage of this $10,000 reduction will have to be paid to the IRS and this is exclusive of the state and regular taxes. If you are already struggling with your debt payments, this may pose a big problem for you.
Unfortunately, unlike your bank, the IRS can initiate criminal proceedings against you. However on a positive note there are ways to wiggle your way out of this situation. For instance, according to a 2007 congress law any reductions that do not exceed $2 million and are offered on your primary residence are exempt from taxes. This means that you have a mortgage of $300,000 and you receive a reduction of $150,000 on it, your bank will certainly let the IRS know about it but according to the new law you will not be required to pay taxes on this amount received as debt reduction.
Additionally, the IRS also offers several recourses to people seeking help with debt reduction related taxes. However, since this is an extremely complex topic, it is highly recommended that you seek the advice of a CPA or a tax attorney before opting for an IRS recommended solution. If you re in Dallas/Fortworth, you can find several eminent tax attorneys who will be able to resolve the situation for you without to much trouble. Remember that it is important to not wait for the tax man to come looking for you, instead start thinking about the method that you intend to use to deal with debt reduction taxes as soon as you initiate talks with your bank about a possible debt reduction or cancellation.
