Monday, June 11, 2012


Will Bankruptcy stop a 1099-C?
Will Bankruptcy negate a 1099-C issued

When you stop paying commercial debts the creditor has the right to  file a  1099-C  for the cancellation or forgiveness of a debt. Bankruptcies are a special case and will stop the issuance of a 1099-C. The theory is that  the amount on a 1099-C represents taxable income to you, the prevention of a 1099-C is one of the added benefits of a bankruptcy discharge. [1]


Therefore If you receive a bankruptcy discharge, the prime benefit is that you do not have to pay your debts with  an added tax benefit of which many debtors are not even aware. The amount of the debt that you discharge in bankruptcy is specifically excluded from your gross income when you file your taxes. In other words discharged debt is not taxable.[1]

Form 1099-C

Form 1099-C is a form creditors use to inform debtors and the IRS of the amount of a cancelled or forgiven debt. While bankruptcy generally stops creditors from sending out this form, in some cases a creditor may send you a 1099-C that indicates the debt was discharged rather than forgiven.[1]

Form 982

Some creditors may send you a 1099-C without the box marked "bankruptcy" checked, even if your debt with them was included in your discharged bankruptcy. In this case, you must file Form 982 with the IRS to indicate that your debt is not taxable. Line 1a of Form 982 allows you to exclude the amount of the discharged debt by indicating that the amount represents indebtedness in a title 11 case. Title 11 simply refers to the section of the U.S. Code that describes bankruptcy, so you can include the amount here regardless of which chapter of bankruptcy you filed.[1]

Cancelled Debt

Do not confuse discharged debt with cancelled or forgiven debt. This is an important distinction because forgiven or cancelled debt is usually taxable. For example, if you negotiate your $100,000 credit card bill to $50,000, you will owe income tax on that forgiven $50,000. If you had instead filed bankruptcy, you probably could have discharged the entire $100,000 without paying tax on any of it.[1]

Debt Forgiveness Is a Taxable Event Pursuant to the Internal Revenue Code & Will Generate a 1099-C[4]
Adding taxable insult to catastrophic financial injury is the fact that “debt forgiveness” will generate a taxable event pursuant to the Internal Revenue Code, §61(a) (12) [Exhibit 1] which succinctly states:
“Gross Income Defined:
“Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:[4]
(12) Income from discharge of indebtedness.”
This “income from discharge of indebtedness” is routinely referred to in short form as “C.O.D. Income” — “Cancellation Of Debt” Income. The theory is that cancellation of debt is equivalent to either “an accession to wealth”[4] or a freeing of assets; money that would otherwise be used to pay off the debt is available to the taxpayer for whatever the taxpayer chooses.[5]
Particularly problematic is the fact that at the time the debt is “forgiven” there is no automatic generation of a 1099-C.  The “C” in the 1099-C refers to “Cancellation of Debt.
The notice from the financial institution may not arrive at the taxpayers (new) residence until January 31 of the following tax year![4]

A few words of caution: if the debt, or part of it, was canceled before you filed bankruptcy (through debt settlement or negotiation, for example), the creditor must issue the 1099-C unless another exception applies. And that debt is not included on Line 1a of Form 982, because it was not discharged in bankruptcy. As a result, even if you later file bankruptcy, you may owe tax on that debt cancellation income unless you were insolvent at the time you settled it.[3]

You do not owe taxes on 1099’s filed after a bankruptcy is filed. You may owe taxes on debts forgiven before a bankruptcy is filed.

Discharge of Debt in a Bankruptcy Is Not Taxable Income, But Will Apply to Reduce “Tax Attributes”[4]
The simple rule is that Debt discharged in a Bankruptcy case is not considered taxable income. However, the discharge of debt must be pursuant to a valid Court Order, or is incident to “Plan” approved by the Court.[4]
Notwithstanding the intuitive simplicity of the Bankruptcy exception, the IRS will apply the amount discharged in bankruptcy to what is calls “tax attributes”, and mandates the filing of Form 982  which is designed to make sure that there is no tax free windfall to the debtor. The presenter would describe “tax attributes” to be other tax advantages the taxpayer may have, which will be reduced to the extent of the Bankruptcy discharge, and include:
  • Net Operating Loss
  • General Business Credit Carryover
  • Minimum Tax Credit
  • Capital Loss
  • Basis
  • Passive Activity Loss
  • Foreign Tax Credit
This is a complex and technical area, which the Family Law attorney or their client, wander at their own peril. This is a compelling reason to follow “Tax Tips Disclaimer—Part B” and retain a qualified C.P.A. to work through these issues on behalf of client.[4]




8th Anual Family Law Institute 11/12/09,Tax Tips for the Practitioner
By James J. Harrington, III, Law Offices of James J Harrington III PLC, Novi

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