Reduction of Tax Attributes Due to Insolvency
For tax purposes, your income and taxable gains generally decrease when you can claim a financial loss or take advantage of a credit on your tax return. The Internal Revenue Service calls these losses and credits tax attributes. When you're insolvent and your creditor, due to your bankruptcy or other cause, cancels your debt, the IRS requires you to reduce your tax attribute.
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Canceled Debt
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The IRS imputes canceled debt to you as income unless you're insolvent or have filed bankruptcy. So, for example, if your credit card company forgave $10,000 in debt, you would report approximately $10,000 of additional income for the year. The exception for insolvent or bankrupt individuals comes at a price. When you exclude your canceled debt from your income for insolvency or bankruptcy reasons, you generally must reduce your tax attribute by the amount you excluded.
Insolvency
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Being insolvent may cause you to have to reduce your tax attributes. If your liabilities exceed your assets in value, then you're insolvent. Everything you own, from your living room couch to your pension plan, comprise your assets. Your liabilities include all your debts ranging from student loans to your car note. Bankruptcy, like insolvency, could also lead you to have to reduce your tax attributes. Consumer bankruptcy generally involves altering your creditors' rights to collect against you by either walking away from the debt or repaying it through a payment plan.
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Tax Attribute Types
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There are multiple types of tax attributes you may need to reduce. Some include the minimum tax credit, general business carryover, basis, net operating loss, foreign tax credits and passive activity loss and credit carryovers. When reducing your tax attribute, you would, for example, diminish your net operating loss by the amount of the canceled debt excluded from your income. If you carried over a net operating loss from the preceding year, you would reduce that amount also. Note, you can't reduce tax attributes to a value below zero.
Form 982
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IRS Form 982 is where you must show you qualify for exclusion of the canceled debt and reduce your tax attributes. In Part I of the form, specify the basis for excluding the canceled or discharged debts from your income. Also disclose the amount of the discharged debt. In part two of the form, list the amount by which you are reducing your various tax attributes. Consult with a qualified tax professional for advice concerning how best to handle your tax attributes.
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References
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