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Insolvency Worksheet

Federal Law requires a financial entity to send a taxpayer a “Form 1099C Cancellation of Debt” whenever it cancels or forgives a loan greater than $600. This may create a tax liability for you because the canceled debt is considered “income” for tax purposes. The amount of debt forgiven must be reported on Form 982 and this form must be attached to the taxpayer’s tax return.

You may be able to reduce or eliminate this so-called Cancellation of Debt Income (CODI) if you were insolvent immediately before the cancellation. For the purposes of completing Form 982, the IRS considers a taxpayer insolvent if the total of all of the person’s liabilities exceeded the fair-market value (FMV) of all of that person’s assets. To determine insolvency, assets include the value of everything the taxpayer owns (including assets that serve as collateral for debt and exempt assets which are beyond the reach of creditors under the law, such as interest in a pension plan and the value of a retirement account). Liabilities include:

  • The entire amount of recourse debts, and
  • The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt.
  • The amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the property subject to the debt is forgiven.

If you receive a 1099C keep it with your other tax documents. Be certain to give the 1099C to your tax preparer, and give the tax preparer information regarding your total liabilities and the FMV of your assets as they were immediately before the cancellation.

The Internal Revenue Service document Publication 4681 contains more information on the tax consequences of canceled debt. It also contains specific instructions on how to complete Form 982. An Insolvency Worksheet should be used to determine the values of your liabilities and assets.

 

 

 

 

 

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