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Debt Relief – Insolvency – Bankruptcy Information » Debt Relief, Insolvency, Mortgage Refinancing » Registered Tax Return Preparer Study Covers Tax Angles for Home Debt Cancellation

Registered Tax Return Preparer Study Covers Tax Angles for Home Debt Cancellation

As an increasing number of individuals are affected by debt cancellation, tax preparation companies are frequently called upon to address this matter. Forgiven debt is usually added to taxable income, but exceptions do exist.

Taxpayers with cancelled debt receive a Form 1099-C from the financial institution where they borrowed money. Because this form is also sent to the IRS, paid tax preparers should not ignore it. The amount on the 1099-C is not taxable if it relates to indirect debt, such as a co-signer on a loan. Only the taxpayer who received use of the borrowed funds is subject to reporting income by not repaying the debt.

However, a borrower with cancelled debt discharged in bankruptcy or caused by insolvency is not taxed on the amount. For these individuals, tax preparation services will include completion of Form 982. This is utilized to report cancelled debt that is excluded from taxable income. It provides sections to describe insolvency at the time of debt cancellation by showing that the taxpayer’s total debt exceeded total assets.

Also excluded from taxable income is cancellation of debt incurred directly for operation of a farm. This only applies to taxpayers earning more than half their income from farming for the prior three years.

The newest type of cancelled debt excluded from income relates to borrowing for a principal residence. The income exclusion for debt cancellation on a primary residence is effective for tax years 2007 through 2012. Even partial debt forgiven in a mortgage restructuring qualifies.

This is an active area of Registered Tax Return Preparer study until the exclusions expire. The maximum income exclusion amount for primary residence debt is $ 2,000,000 – but is limited to $ 1,000,000 for married filing separate status. The exclusion requires that the cancellation of a mortgage debt have a direct relation to a decline in the home’s value or the taxpayer’s financial condition. In addition, the cancelled primary residence debt must constitute borrowing to buy, build, or improve the house. Home equity loans do not count.

Unless there is an extension of the tax provisions for income exclusion of cancelled debt on a primary residence, the RTRP exam 2013 will change how debt cancellation is addressed. However, tax preparers should retain their familiarity with this tax issue when preparing any previously unfilled returns for tax years 2007 through 2012 that have cancelled debt.

IRS Circular 230 Disclosure

Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.

Fast Forward Academy is a leading publisher of education for tax preparation companies and tax professionals. Access to free questions for the paid tax preparers is available on their website.

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