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Debt Relief – Insolvency – Bankruptcy Information » Bankruptcy Help, Insolvency » Basics of Cancellation of Debt Income

Basics of Cancellation of Debt Income

Cancellation of debt income may be defined as the amount of debt forgiven by a creditor without requiring any considerations in return. The amount of debt forgiven by the cancellation of debt by a creditor might be considered as income to the debtor and hence would have to be reported as part of the individual’s gross income. Usually, such income might fall under the tax purview and may be taken up as ordinary income to the taxpayer. Hence the amount would be known as cancellation of debt income or CODI. If the cancellation of debt income might be taxable, then the debtor would be given a Form 1099-C at the financial year end where in the amount of the forgiven debt would be shown as taxable income. For example, if a bank lent $ 10,000 to Mr. Jones and Mr. Jones pays back $ 6,000, and then might be unable to pay the remainder, the bank may forgive the $ 4,000 difference, which would be recorded as income for Mr. Jones.

Not all cancellation of debt income may fall into the category of income while calculating a debtor’s gross income. Some COD would be excluded. If the indebtedness discharged occurs in a title 11 case, or occurs when the taxpayer is insolvent, or might be qualified for farm indebtedness and if the indebtedness discharged might be qualified real property business indebtedness; then the income from the cancellation of debt would not be considered to be a part of an individual’s gross income and hence wouldn’t fall under tax purview.

Debt reduction would obviously be the result of a cancellation of debt for any individual as the person no longer would be liable to pay off the debt that might be forgiven by a COD. One must try to work towards debt reduction in case of huge debts by budgeting one’s income and living within one’s means. One may also stop using credit cards and use them only for emergency contingencies and try to pay the credit card bills in full before the payment due date so as not to accrue high rates of interests. When a person opts for cancellation of debt, the debt burden might be reduced and there might be temptation to get into the old routine of spending beyond one’s means and getting back into the debt burden cycle. Budgeting, credit counseling and debt consolidation might be some ways to help reduce an individual’s debt. In extreme cases, debt settlement might also prove to be a good option and these procedures may not affect one’s tax liabilities.

Debt settlement might prove to be a good option for debt relief as the amount of debt that might be forgiven by the creditor would not be considered as income from debt cancellation. This might be so because the debt would be negotiated by a third party, often a debt settlement company. The effect of debt settlement might be seen in one’s credit rating but would not affect one’s gross income in any way. Though debt settlement might negatively impact one’s credit rating, it would not increase a taxpayer’s tax liability. Before deciding to go in for a cancellation of debt, it might be prudent to consider debt settlement programs. A debt settlement program might typically be for three years. It might be noted that while in a debt settlement program, there would be no payments made to the creditors for the duration of the program. This would lead to the debt account to go into delinquency status and the creditors might forward the delinquent account to collections. The calls from collections might be harrowing but in the end might be worth all the trouble taken to be debt free.

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