Taxation of Forgiven Debt

Many individuals are unaware that when a creditor forgives a debt that the individual owes, the forgiven debt is considered income for purposes of their tax returns.  The IRS and the State of Michigan both tax the forgiven debt, often creating large liabilities on the part of the tax payer.
It is important to note that there are exceptions to this general rule.  Individuals who receive a discharge of their debts under the Federal Bankruptcy Code are not subject to tax liability on the forgiven debt.  Additionally, individuals who are considered insolvent are not liable for taxation.  Finally, debt related to an individual’s mortgage on their primary residence is not taxable upon forgiveness.
These exceptions are located in Section 108(a)(1) of the Internal Revenue Code.  In the event an individual finds themselves in receipt of a 1099(c) from a creditor they need to be sure and have their tax preparer file Form 982 along with their Federal Income Tax Return.  If your preparer is unaware of the rules regarding these exceptions, it may be best for the individual to seek the help of a more qualified professional.