Are you one of the many who think that in order to save taxes, you have to first generate some sort of income? Though many consider tax planning and tax savings to be one in the same, let’s not get ahead of ourselves. After re-negotiating credit card debt, some find that they still owe thousands of dollars of taxes towards the IRS. How does this happen? In the event that a lender decides to forgive debt, the forgiven debt then becomes Cancellation of Debt, also known as COD income, which means it is taxable.
Cacellation of Debt Income
COD income must be reported on Form 1040. Take this situation for instance. You have about $25,000 of credit card debt to your name and you know you won’t be able to pay it off, so you get help from a credit counseling company that writes down your debt to about $5000 if you can pay the amount within 30 days. Perfect! You scrounge up any money you can, sell a few items, and borrow some cash from your grandmother and before you know it, you have and pay the owed $5000. Great, right?
A few months later you check the mail and you see a Form 1099-C sent from the credit card company that claims you have $20,000 worth of COD income. This means that, just as you would pay taxes on normal income, you now have to pay taxes on the $20,000 as if it was handed to you in check form. The amount of taxes you have to pay on the money will depend on the tax bracket you fall into.
Home Lose Due To Foreclosure
The same situation often occurs with those who lose their homes due to foreclosure. Weeks, monthly, or possibly even years later the ex-homeowner will receive a Form 1099-C showing the amount of debt forgiveness and the taxes that must be paid on the forgiven debt. Many times these situations lead to a big tax problem. Not only are people unable to pay their debt or keep hold of their homes, they now have to worry about a whole new issue – taxes. Thankfully, Form 982 is a solution for many of those who fall into these situations.
With these form, there are exemptions that may mean that you do not have to pay taxes on the forgiven debt. Exemptions include bankruptcy, primary residence indebtedness, and insolvency. While Form 982 may work for some, it isn’t that cut and dry. The form must be properly completed to the T or the exemption will be lost.
What’s most important in these situations is that if you do receive a Form 1099-C in the mail, do not ignore it. The form open the door to possible exemptions, so don’t waste your chance. In bad times as well as good times, tax planning is a must. Don’t let taxes ruin your financial situation.