How to File Insolvency With the IRS

Whenever a financial institution cancels all or some of the debt you owe, you are issued a 1099-C, reflecting the amount that was settled or cancelled. A financial institution can also issue a 1099-C if there is a repossession of collateral such as a car or a home in which the repossessed property does not cover the entire debt owed. You are issued a 1099-C for the balance. You may also be issued a 1099-C if the creditor has exhausted all attempts to collect the debt and has deemed it irredeemable.The IRS considers any amount reported on a 1099-C as taxable income unless you can prove insolvency at the time of cancellation.

Instructions

1. Compile your 1099-Cs if you received more than one and add up the entire amount. For example, if you owe $10,000 on a credit card and you settle the debt for $5,000, the credit card company would write off $5,000 and report this to the IRS on a 1099-C. The IRS would technically treat the $5,000 as income. Creditors are required to report debt cancellation or settlement that is $600 or higher to the IRS.

2. Make a list of your assets. Your assets would include all the valuable things you own that could be sold for cash. These include your home, car, jewelry, artwork and other valuables. Determine their fair market value from documentation that shows current market value or current appraisals.

3. Make a list of your liabilities. Your liabilities will include any debts, including debts owed on some of the articles listed as part of your assets.

4. Create a financial statement, which is a table of your assets compared with your liabilities. If the total amount of your liabilities in dollars exceeds the fair market value of your assets at the time you received any form of debt cancellation or settlement, you are deemed by the IRS as insolvent. If you are insolvent, you are not required to report the amount on the 1099-C as income. However it is advisable to file for insolvency because your creditors would have sent copies of your 1099-Cs to the IRS.

5. Filing IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, with your tax return. You may also send the IRS a detailed letter with a financial statement showing your insolvency.

Tips & Warnings

• The IRS forgives treating canceled debt as income only to the extent of insolvency. For example, if the total value of your assets is $80,000 and your total debt it $100,000, you are insolvent by $20,000 and only that amount of canceled debt can be excused from being taxed. So if you receive a 1099-C reflecting a debt cancellation of $25,000, $5,000 will be taxable.

References

• IRS: Home Foreclosure and Debt Cancellation

Resources

• IRS: Form 982 - Reduction of Tax Attributes Due to Discharge of Indebtedness