Sometimes life gives you lemons and you may have more debt than you can handle. In times like such you can try to talk to your lenders and see if they are willing to cancel some or all of your debt. They will in return see a tax credit for the amount. There are rules you may want to read below.
https://www.irs.gov/publications/p4681#en_US_2020_publink100033600
If they agree to cancel debt there maybe a tax burden for you for the same amount. You will owe tax on the debt canceled because it is considered income.
You can try to do an insolvency worksheet to reduce this amount. Please see the worksheet below.
I also created an excel sheet of this form to make it easier. See it attached here:
I made this excel sheet for a client:
Insolvency Worksheet
Don’t include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You don’t qualify for the insolvency exclusion by being an owner of, or a partner in a partnership that owns, a grantor trust or disregarded entity that is insolvent. You must be insolvent to qualify for this exclusion. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets, which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include:
- The entire amount of recourse debt,
- The amount of nonrecourse debt that isn’t in excess of the FMV of the property that is security for the debt, and
- 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.
Disclaimer:
THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND THAREJA, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.
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