Why a Bankruptcy Petition Is a Better Option than Debt Forgiveness

The Different Tax Implications of Discharge and Debt Forgiveness

Let’s face it…there’s a certain stigma associated with filing for protection under the American bankruptcy laws. For that reason, you may think it’s a better idea to work with a debt counselor, someone who will work with your creditors to negotiate some type of forgiveness of your financial obligations. If you have mortgage debt that you can’t pay, you may think it’s best to sell your house “short,” for less than you owe the bank, and just let the bank forgive the difference. It sounds attractive, but it’s a bad idea.

How Debt Forgiveness Is Treated for Tax Purposes

When a creditor agrees to forgive a debt—wipe out some or all of a financial obligation you owe—the Internal Revenue Code considers that a “benefit conferred” to you. In essence, it’s viewed no differently than if you had received the amount forgiven as income. In fact, that’s exactly how it will be treated. Don’t be surprised if the creditor who forgave the debt sends you a 1099, which must be reported as income. As a general rule, when a bank forgives some part of a mortgage in a short sale, it sends a 1099 and reports the amount forgiven to the IRS as income.

How Discharged Debt is Treated for Tax Purposes

Unlike forgiven debt, any debt that is discharged, either in a Chapter 7 liquidation or a Chapter 13 reorganization, will not be considered income for tax purposes. Accordingly, the discharge of debt is a tax-free event (for most consumers).

Contact Attorney Howard N. Sobel

At the office of Howard N. Sobel, we provide personal bankruptcy counsel to men and women throughout the state of New Jersey. Contact our office online or call us at 856-424-6400 to set up a free initial consultation.Evening and weekend appointments can be arranged upon request. We accept all major credit cards.

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