Debt Forgiveness Is Great But Is It Really?


Here’s a quick quiz – who is the more understanding creditor – the government or private business? No, that’s not a trick question. It’s just that when you take debt forgiveness up as the criterion to judge a lender by, you have to admit that government can be the harder of the two to reason with. If you’re unable to pay your loan back, a bankruptcy court can make a private lender step back and free you of your obligations, and it would be okay. But when the IRS sees that you have received all this money from the private lender and you don’t even have to pay it back, they’ll consider it a gift. And they’ll make you pay taxes on it.

So now with this in mind – who is the harder creditor of two?

Well, there are some exceptions to the cancellation-of-debt taxation thing that everyone hates and fears. Let’s look at what they are.

If your bankruptcy filing is a Title 11 process, you’ll find that you are completely exempt. But there’s another problem here – when you enter the bankruptcy process, right away, the law creates a separate estate in your name – called your bankruptcy estate. And whatever money is moved by the court intoe that estate, you do owe taxes on that.

What happens when you’re insolvent even before you actually enter bankruptcy court? This would happen if you weren’t really filing for bankruptcy, but your situation completely warranted it. In that case, when you actually do file for bankruptcy, whatever debt forgiveness you are granted, that is considered exempt. They call it an insult since the exception.

How about the deductible interest exception? If the debt forgiveness in question includes some kind of interest that you owed at some point, and it was just added to the principal that you owed originally, you could be in luck. That money cannot be taxed by the IRS. Yes, it’s quite complex – but it does end up saving you thousands of dollars.

There are all kinds of other such unsecured debt forgiveness tax clauses that could save you money. You would really have to engage the services of a good tax lawyer – have him at your side – to be able to recognize all these. You shouldn’t grudge him his fee though – he does manage to save you lots of money.

When you are forgiven the tax that you owe the IRS on forgiven debt, the IRS expects you to pay a price for the privilege. If you have enjoyed any tax concessions elsewhere – tax credit carryovers and so on, the IRS would like a bite out of that.

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