Form 982 – Everything You Need To Know
Most of us file our taxes in a very straightforward manner. We go to a job, that job gives us a paycheck (with taxes already taken out), and at tax time we simply use Turbo Tax (or similar software) to file our taxes.
But if you start to run into financial issues, or have any income situations that are more complex than this – you can quickly get a headache. That’s because the IRS is known for their confusing, almost byzantine, rules and regulations.
Form 982: The Reduction Of Tax Attributes Due To Discharge Of Indebtedness
What a mouthful. What does any of it mean? Let’s start at the beginning.
When you bring in money, you need to pay taxes on it. This usually takes the form of income tax.
Seems straightforward. For most of us, this applies to our regular paychecks: you get paid, you pay income tax based on how much you got paid.
But there are so many other forms of income as well that will require you to pay taxes, and sometimes what’s considered income isn’t just actual money you’ve brought in, but value you’ve obtained through other circumstances.
Sometimes that value takes the form of having debts canceled. When, for one reason or another, you had debt that you are no longer required to pay, the IRS considers that income.
You owed money, now you don’t, so you’ve gained value and the IRS wants their cut.
Canceled debt may take the form of a creditor agreeing to forgive the debt, or forced cancellation, like when a judge orders it through bankruptcy. The value of that cancellation can be considered income.
It doesn’t sound fair. You didn’t actually bring any money in, but you still have to pay money out.
The good news is, you may be exempt from income tax.
IRS Tax Exemptions
Tax codes are complicated, largely due to how many different exemptions and deductions someone can take. Discharged/canceled debt (debt you no longer have to pay and which the creditor is no longer allowed to try to collect on) is one of those cases.
When a creditor cancels the debt, they’ll send a 1099 form to the IRS, indicating they’ve given you value – in other words, income, which generally would be taxable.
But you may not have to pay those taxes, if your debt falls under one of the following exemptions.
Bankruptcy (Title 11)
There are many reasons why someone might file bankruptcy, but the result is the same: a court orders the cancelation of debt when a debtor proves they can’t pay it. When a judge grants an order of bankruptcy, you may be exempt from tax for the full amount of the debt.
If you’ve filed for bankruptcy, you’ve likely already got a bankruptcy lawyer who can help guide you through the process including figuring out whether your discharged debt will be exempt from income tax, but Publication 4681 from the IRS can help you determine the qualifications on your own.
Insolvency is a common, but complicated, way someone might be exempt from paying income tax on their canceled debt. It’s similar to bankruptcy in that it indicates an inability to pay debts, but rather than having a court order, you’re obligated to determine your insolvency status yourself and prove it to the IRS.
You’re insolvent when your total value – all the money you have, and the value of all your assets added together – is less than the amount you owe. Even if you sold all your stuff and drained your bank account, you still couldn’t pay your debt.
When proving insolvency to the IRS, you can use Publication 4681 from the IRS to figure out and show your insolvency. This is an “insolvency worksheet” to help you determine your insolvency, taking you through each step of tallying your total debts and your total assets (and can help you understand what counts as debt or assets if you’re having trouble).
If you find yourself insolvent, or in any other circumstances allowing for exemption of income tax on your canceled debt, you may not have to pay income tax on the value of the canceled debt. But you can’t just cross it off your income and be done, and that’s where form 982 comes in.
Qualified Farm Debt
When debt related to running a farm is canceled, it may be exempt from income tax under the qualified farm debt exclusion. This debt must be directly incurred for the business of farming, must be incurred by someone whose majority business is farming, and is incurred from a “qualified person,” a person otherwise unconnected with you or the property.
Qualified Real Property Debt
Debt that is secured by and connected to real property used in a business may be partially or entirely eligible for exemption, based on a few additional qualifications like when the debt was incurred. The definitions and qualifications can get tricky, but a full list of exclusions can be found in Publication 4681.
Qualified Principal Residence Debt
Qualified principal residence debt deals with mortgage cancellations for your home. This would be considered your principal residence, but this type of debt cancelling also covers connected debts related to refinancing your mortgage.
Your principal residence is your main home, the one (and only one) you live in most of the time.
More Information About Form 982
As the form states, it is for “reduction of tax attributes due to discharge of indebtedness”. Hopefully those words seem less foreign now.
Even though canceled debt counts as income, when you meet the qualifications for being exempt, you won’t have to pay income tax on it. Form 982 will take you through each step in declaring which debt you’re exempting from your income tax, and the reason why.
This form will be filled out and filed along with your regular tax return, and must be filed if you intend to exclude any canceled debt from your income tax. Specific instructions for filling out the form can be found on the IRS website.
Even if the purpose of the form may be more clear, the specifics of the qualifications for exemption can still be ambiguous or vague, or downright incomprehensible to a layman. The IRS has attempted to rectify this by providing Publication 4681, to help understand the terms, definitions, and complicated list of rules associated with the cancellation of debt.
Publication 4681, also released by the IRS, provides guidelines and more specific instructions for determining which debt may be exempt. When filling out form 982, it would be useful to have Publication 4681 on hand to help guide you through and determine your debt’s exemption qualifications.
If you’re trying to fill out form 982 on your own and get in over your head, giving this publication a read can help clear things up for you. However, we still recommend utilizing a qualified tax professional for all your income tax needs.
What Does This IRS Form Cover?
Weirdly, debt you no longer have to pay is still considered taxable income by the IRS. While this technically fills their check box of taxable income, a qualified tax professional may be able to help you avoid paying tax on debts that were canceled.
Discharged indebtedness is another confusing term, which makes reference to debts that are cancelled due to filing for bankruptcy. There are also other confusing (yet applicable) terms and situations here, like qualified principal residence indebtedness, as well as qualified farm indebtedness.
Explaining and covering all of these different terms is beyond the scope of this article, but this again goes to show why your total amount of taxable income may not be what you think it is.
Additionally, you have to consider things like repossessions, the total amount of income you made in a calendar year, and the tax year of the discharge of any relevant debts you may have owed.
These are all good reasons for having a qualified tax professional file your income tax returns – rather than trying to handle everything yourself.
What Exactly Does The IRS Consider Cancellation Of Debt?
There are many different scenarios which the IRS will consider cancellation of debt. There is the ‘discharge of qualified real property business indebtedness’ – which is as confusing as it sounds.
Then there is the ‘discharge of qualified principal residence indebtedness’ – which is different, but also relevant here. If you have credit card debt cancelled – the IRS also looks at that as possible cancellation of debt – which may require paying taxes.
Other Factors To Consider For Form 982
Whether federal or state, taxes always look at your gross income – and the average taxpayer can’t use any loopholes or make unreasonable deductions to try and avoid taxes. If you’re a lender, you will likely want to avoid those with poor credit, or those who have had a foreclosure.
No matter your taxable income, the Internal Revenue Service will always require its fair share. If you are cancelling nearly any amount of debt using form 1099-c, you should alert the IRS to this cancelled debt.
Credit card debt is different than debt income – and both of those are different than the type of debt that can be canceled with form 982. Because of these complexities, the Internal Revenue Service may require additional information about your finances.
Any nonbusiness debt should be accounted for on your income tax return, and due to the complex nature of these forms and filings – we recommend all tax preparation be done by a qualified tax professional.
The Bottom Line On IRS Form 982
Due to the complex nature of utilizing form 982, we recommend your tax preparation be done by a qualified tax professional. These professionals will know about things like tax carryover – which lets you claim a deduction over multiple years – and they will also know about things like fair market value.
These details may seem insignificant, but terms like ‘depreciable property’ and ‘basis adjustment’ can make all the difference when it comes to filing your taxes properly. While you may know general information about taxes, tax professionals know much more – and they can use this information to help you.
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