Feb 6

Debt Forgiveness As Income


Chapter 7 and Chapter 13 bankruptcies generally result in a large amount of debt relief. When this occurs debtors may find that they begin receiving IRS 1099 forms from their old creditors, especially if the amount of debt relieved in regard to any particular creditor exceeds $600. I find that receiving one of these tax forms as the result of a bankruptcy case can cause a debtor client to have kittens, often resulting in urgent telephone calls questioning why they are receiving all this phantom income as a result of their Chapter 7 or Chapter 13 bankruptcy filing. After all, was not the purpose of filing to get out of debt and get a fresh start, not to get a big tax bill after the bankruptcy.
The truth of the matter is that these 1099 forms are just a matter of bank or credit card company procedure. When they write off the bad debt they file the form without looking into the reason much. Either that or they just want to get one more kick at the cat and give the debtor a scare. The fact of the matter is that debt relief or forgiveness resulting from a bankruptcy does not result in taxable phantom income. Here are the exceptions from having to pay tax on the phantom income created when debt is forgiven. This all comes from the Internal Revenue Code, title 26 of the United States Code.

§ 108. Income from discharge of indebtedness
(a) Exclusion from gross income
(1) In general Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason
of the discharge (in whole or in part) of indebtedness of the taxpayer if—
(A) the discharge occurs in a title 11 case, (case under the bankruptcy code)

So there is no need for panic or concern if a debtor receives one or more 1099 forms after completing a chapter 7 or 13 case and receiving a bankruptcy discharge. It just needs to be handled when filing the tax return with an explanation as to how and why the phantom income arose.

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