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The truth about being INSOLVENT...ChrysHenderson please read

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Okay, on another post I think that there was some confusion or fear about having to claim money saved from debt settlement as income earned on your taxes. I would like to clarify and also reiterate some things about that.

Debt settlement is a much better solution for a great majority of us. We all know that here. What isn’t commonly known is that creditors are required to report forgiven debts greater than $600 to the IRS on form 1099. This notifies the IRS that you have settled your debt for less than full balance. Here’s the thing: the IRS views this cancelled debt as taxable income and wants you to pay taxes on it.

Don’t freak out though - there is a bright light in this dark tunnel for MANY of us that see debt settlement as the best or only way out.

The truth is that many of us who choose to go the debt settlement route are NOT liable for taxes on the forgiven debt. The IRS gives an out for debtors who are “insolvent” at the time of debt settlement. The term "insolvent" does NOT...I repeat NOT only apply to people filing bankruptcy!!!

The term “insolvent” simply means that your debts exceed the value of your assets. If you are in a situation where a debt settlement is necessary, you are probably insolvent. In other words, you would have a negative net worth where your liabilities outweigh your assets.

So How Do you figure out if you are insolvent?

At the end of the year, you’ll get a 1099-C from the creditor with which you settled. The 1099-C will usually have a DATE that your debt was cancelled, and it should match your records with the time you settled and actually paid your creditor.

This cancellation date is important because that’s the point of reference to determine your solvency. List all your assets and liabilities(debts) AS THEY STOOD ON THAT DATE. Use market value of your house and cars to determine their value as an asset. To determine your home's value you can use a site like zillow or some of the other ones that give free desktop appraisals simply by typing in your address. They include comparable values (surrounding home sales) so the estimate should be pretty accurate. There are also great sites out there to help determine the value of any cars that you own free and clear.

If your debts exceed your assets for that date in time, and the amount you are insolvent to exceeds the cancelled debt amount, then you can declare yourself “insolvent” for that settlement. If you settled more than 1 debt, you must repeat this process for each cancelled debt.

To let the IRS know about your insolvency, you must fill out IRS Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness. You would then attach this to your 1040.

If you determined that you were insolvent on your debt cancellation date, then you need to attach some documentation. According to the IRS phone support rep, a simple spreadsheet showing your assets and liabilities like this will suffice:

List of Assets and Liabilities

1099-C Creditor: American Express
Cancellation date: 03/27/2008

Debtor: Joe Schmoe
SS#: 123-45-6789
Tax Year: 2008
Loan Balance: 7890
Amount cancelled: 5623

House: 150,000
Car 1: 5,400
Car 2: 3,200
Check.acct: 364
Savings acct: 0
Household items: 2,200
Total assets: 161,164

Mortgage: 124,000
HELOC: 4,200
Credit card debt: 46,000
Total liabilites: 174,200

174,200 in Liabilites
-161,164 in Assets
= 13,036 INSOLVENT

I was insolvent to the amount of $13,036 on 3/27/2008, which exceeded the cancelled debt of $5623, therefore, I am not including the amount reported on the 1099-C on my tax return.


You should do this for each cancelled debt for which a settlement occured in the given tax year.

If you determine that you would not be considered insolvent, keep in mind that the amount you settled on added to the taxes you will owe is STILL much less than what you would have paid to the creditor in the long run. Especially if you had gone on paying minimum payments! Chances are that the interest alone on the payments you would have made far exceed the amount of taxes assessed.

Either way, you save money, eliminate your debt and get to sleep at night. You still won by settling your debt.

never once in your post do you list income.why is that?that is one of the if not the big factor in determining whether or not you are insolvent.after all of the assets are brought out in the open.then they look at your income,are you the head of a household,how many dependents.if someone's income is say 45,000.00 i don't think that qualifies as insolvent.

Sub: #1 posted on Wed, 02/25/2009 - 21:13

paulmergel paulmergel
Moderators Cum Industry Expert
(Posts: 15506 | Credits: 1356.56)

Canceled debt is not included in gross income if the cancellation takes place in a bankruptcy case under the U.S. Bankruptcy Code, OR if the cancellation takes place WHEN YOU ARE INSOLVENT.

Sub: #2 posted on Wed, 02/25/2009 - 21:21


I think the original poster is right on this one. Being insolvent determines your taxable income. Your taxable income does not determine you being insolvent.

Sub: #3 posted on Wed, 02/25/2009 - 21:34


The tendency for many who have to, or volonteer to, tackle this topic, is to confuse means testing for chapter 7 with the code section dealing with insolvency. They are totally separate as indicated by the first post in this thread.

The formula is not income-centric. It is liability-centric.
In other words, you owe more than your worth exclusive of income.

I realize this has been hard for people to grasp. I attribute that to not speaking direct to a tax professional who knows how the code section is applied. Some tax professionals themselves dont know how it is applied and will say it only applies to a BK. They are wrong and you are talking to the wrong person if they answer this way.

Sub: #4 posted on Wed, 02/25/2009 - 23:16


I do not know if the insolvency calculations shown above are correct or not but it does not make sense to me that the calculation would not take in to account income. What if the person above makes a large annual income? I could understand the calculation if their income was just barley enough to cover their monthly bills but what if that person makes six figure money. Someone could easily waste all of their money even in the six figure range on items that would not go into that calculation thus they would appear insolvent when in reality they would not be.

Sub: #5 posted on Wed, 02/25/2009 - 23:39

Moderators Cum Industry Expert
(Posts: 1078 | Credits: 137.97)

Nothing personal here, but this topic is a very real concern for people. It will truly have an impact on their decision making process and their bottom line as well. Board moderators and participants with mucho posts and really good comments on other topics are looked to as an authority whether they like it or not and yet, they are responding to this topic without having any background, knowledge or research. This ultimately hurts the people coming here for help and answers. May I suggest the necessary detail be researched fully by someone in a position to do so and it be posted as a sticky for future particpants. There is far too much misinformation on this issue on the net and feeding into it does this whole board a disservice. Nascar made a reference to an enrolled agent on the other thread. That would be a good place to start.

Further; Check with a tax professional as it relates to this code section and how it applies to you. If they answer with something like "This does not apply to you because you were/are not in a BK process" advise them to do their research and get back to you or seek out competent advice.

Sub: #6 posted on Thu, 02/26/2009 - 00:01


Here are some links to some articles that better explain " insolvent ". One if written By Charles Phelan who has worked in the settlement industry for years. This other article better explains the whole process of debt settlement, income taxes and being insolvent.

Sub: #7 posted on Thu, 02/26/2009 - 00:07

mobile0311 mobile0311
(Posts: 1817 | Credits: 104.57)

I don't know why everyone is making this so confusing. It doesn't have to be. Income has NOTHING to do with being insolvent. If you have more debt than assets, you are insolvent. Period. And yes you can be insolvent without claiming bankruptcy.

Sub: #8 posted on Thu, 02/26/2009 - 01:50


Can anyone who has already been through debt settlement and claimed to be insolvent on their taxes comment on this subject?

Sub: #9 posted on Thu, 02/26/2009 - 08:37


I agree, the definition of insolvent doesn't have anything to do with your income. It just means you have a negative net worth. It is akin to the bottom line on a company's balance sheet. If you were to die today, your assets would not cover your liabilities.

Theoretically, if you had a lot of income, you shouldn't remain insolvent for very long, because you should be saving some (and your savings would be an asset). But even if you make $150K per year, if your expenses are $149K, then when all is said and done you've only increased your assets by $1K.

Sub: #10 posted on Thu, 02/26/2009 - 10:26

DebtCruncher DebtCruncher
(Posts: 2296 | Credits: 269.79)

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