BRUCE C. TRUESDALE
MEMORANDUM FOR OUR CLIENTS REGARDING THE EFFECT ON YOUR INCOME TAXES LIABILITY OF HAVING YOUR DEBTS DISCHARGED IN BANKRUPTCY
Many clients ask us if filing bankruptcy has any effect on their income tax obligations. Although we do not hold ourselves out as income tax experts, generally we understand that the answer is NO.
Generally, when debt is reduced or gotten rid of for less than its face value or charged off, this results in taxable income. However, Internal Revenue Code Section 108 provides a specific exception for bankruptcy.
More specifically, Section 108 provides for an exclusion for “Disharges in indebtedness in Title 11 cases” This means bankruptcy. All bankruptcy cases are filed under Title 11. Therefore, the reference to Title 11 is just another way of saying bankruptcy.
This issue generally comes up when clients receive some sort of a Form 1099 from the creditor whose debt has been discharged. When a client receives a Form 1099, this means that the creditor is reporting the “charged off” debt to the IRS for income tax purposes.
When this happens, we get asked whether or not they need to include the income from the Form 1099 on their tax returns. The answer is “yes”, but it is not taxable as long as the client files with their taxes an IRS Form 982. By filling out and filing this form, the client is claiming the Section 108 exclusion, which completely excludes the reported income, so that the net effect is that there is no tax on it. Please note: The 982 form must be filled out and filed however. The exclusion is not automatic unless the form is filed.
Where do I get the form?
If your income tax preparer does not have the form, you can get a copy by going to the official IRS website at www.irs.gov
Caution: For a more in-depth understanding of section 108 and other provisions of the tax code, or possibly exceptions to the application of the “bankruptcy exclusion”, please refer to your tax accountant or tax attorney.