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Debt cancellation and income tax implications

A New Jersey resident who is dealing with significant levels of debt may look at various options in attempting to obtain relief from high bills. Some will consider bankruptcy, but there may be an interest in avoiding this avenue by negotiating lower payments directly with debtors. It should be noted that cancelled debts may carry certain tax consequences.

If debt is forgiven, a form 1099-C might be issued by a credit card company or other creditor. This form represents income that has been gained through forgiven debt. Even if part of the debt is repaid, the forgiven portion might still be included on this type of tax form. This may be surprising, but a borrower who seeksa loan through credit card use or another avenue has an obligation to repay the amount borrowed. When that obligation is dismissed, the amount may be viewed as income.

The most common situations leading to receipt of a 1099-C include cancellation or reduction of credit card balances. However, this may apply to other types of unsecured debt as well. There are some situations in which cancelled debt might not be viewed as income. Bankruptcy is one such instance, and discharged debts in this case are not taxable. Insolvency is another such situation. This occurs when one's assets are valued at less than one's debts. While this may be a helpful avenue to explore before filing a tax return, professional assistance may be important for correctly approaching the issue.

An individual who is unsure about whether to file for Chapter 7 bankruptcy or to seek independent resolutions to credit card debt may want to discuss the options with an attorney first. This may provide the insight needed to determine whether the tax implications of forgiven debt are manageable or whether bankruptcy is a better avenue for overcoming burdensome oblgiations.

Source: Monterey Herald, "Barry Dolowich, Tax Tips: Cancellation of debt income", Barry Dolowich, Feb. 17, 2015

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