As I was reading through some of the stories on Zerohedge a few weeks back, one particular headline stood out about the subprime auto loan industry.
The gist of the article was the largest subprime auto lender had to delay their earnings reports due to, “accounting matters.” This would seem to imply that the subprime auto loans are not performing as expected and most likely there are some serious valuation issues. It would also imply that defaults, auto repossessions and loan discharges are coming- not only in the auto industry, but across the lending industry as a whole.
The Debt Settlement Call
Anyone who has been in a financial pinch knows about the dreaded debtor settlement call or the settlement letter received in the mail. The pitch delivered is usually the bank will write off a significant portion of the outstanding balance for a payment by X date, somewhere on the order of 50% of the outstanding balance on the money owed by you. Sounds great, so you bite and accept the offer, or maybe you avoid the call and the bank discharges the debt anyways. It’s like the universe is smiling at you, and just as you can’t hear anything over how awesome you are.
Sometime in February of the following year, a 1099-C shows up in your mailbox? When you look at the form, box 2 lists the total amount of debt discharged now as income received by you. Even worse, it’s untaxed income.
Let’s take a very general overview of debt discharges (not including bankruptcies) in this edition.
But First, The Required Legalese…
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
How the IRS Views Debt Discharges
As mentioned in previous blogs, there is no such thing as a free lunch in taxation. Generally speaking, if one party deducts an expense, another party records taxable income.
When you first take out a loan and fill out all the documentation, you are contractually obligated to pay all the money back. When the bank opts for a partial or full discharge of the debt, the bank, in effect, voids the contract and the obligation to repay the discharged debt. Once the contractual obligation to repay is gone, the IRS views this discharge as the bank paying the taxpayer with free income, which is taxable.
The bank receives a tax deduction for the discharge, and you receive taxable income from the discharge.
Some Exemptions and Exclusions to Debt Discharge Income
So the general rule of discharged debt is you are required to report all discharged debt as income unless exclusion applies. The three of the most common exclusions are:
- If your debt was discharged as a result of a Title 11 bankruptcy (this includes chapter 7, 11, and 13 bankruptcies),
- If just before your debt was discharged, you were insolvent. Before you get too excited, the IRS, for your convenience, provides an insolvency worksheet (https://www.irs.gov/publications/p4681/index.html#en_US_2015_publink100024659) to determine if this applies to your situation. The general rule in this scenario is that your exclusion is limited to the extent that all of your liabilities (what you owe) are greater than your assets (what you own) immediately before the cancellation as determined by the worksheets. So, if the total discharge was $1,000 and after completing the insolvency worksheet, it is determined that your total insolvency (Liabilities-Assets) was $600, you would still have $400 of taxable income to report.
- If your qualified principal residence debt was discharged, generally speaking, you can exclude up to $2 million for a married couple, $1 million for a single.
All of these exclusions would be reportable on a Form 982 (https://www.irs.gov/pub/irs-pdf/f982.pdf).
Wrapping it Up
Before blindly agreeing to a debt discharge and thinking you got over on the banks, be aware of the tax ramifications you could be placing yourself into.
Have a tax question? Please feel free leave a question in the comment section below and I may feature it in a future blog post.
I do use it to my advantage as far as paying off debt, and with private trusts to create valuable assets almost out of thin air but you have to have an assets or a Title to something to give it the value, thats where it comes from but, you can put you Birth Certificate in your private trust and the value would go up to a couple million same with your social security card , and you can re-order more of those and put those in too, thats why they say your Birth Certificate is worth Billions!
If you want to learn more about this I have a website that can help you just go to my profile page here on steemit and you will see several blog posts I created on this and my website for more.
Nice article buddy. Like it. keep posting good work @lpfaust
Thanks vishal1. Taxation isn't a sexy topic, but it's a necessary one. Unfortunately the Steemit community at large does not seem to think so. I suppose we will have to see come tax season.
Well so far from what I see most of the steemit community believe that, "Taxation is theft" and I concur. Good article though, entirely factual afaik.
I picked up on that as well, which is why I get downvoted on these articles quite a bit. I could understand the downvotes if I posted a pro tax position which they fundamentally disagree with. Downvoting factual information posted for the purpose of informing and educating? I don't get it.
The purpose of these articles is not to stake out a pro or anti tax stance, it's simply to educate the community at large of what the Internal Revenue Code lays out as their obligations as taxpayers, and what consequences could result from failing to follow through on those obligations. It's simply about informing and educating the community.