The Payroll Protection Program or P3 has been one of the things that has kept many small businesses together. Now that loan cancellation requests are available, many businesses are wondering if they will qualify and how to be sure. For an excellent summary of the PPP land configuration, see May 22 final draft PPP rules provide further guidance. More generally, it’s worth reviewing the ground rules and why the IRS typically taxes loan forgiveness in the first place, since the IRS usually considering tax rebate on loans. Whether you like it or not, when a debt you owe is canceled or discharged, in many cases the tax code treats the canceled debt as cash income for you. In most cases, if you owe the bank $ 500,000, but the bank forgives you, it’s like the bank just gave you $ 500,000 and Uncle Sam wants his share. In the tax world, COD is the abbreviation for debt cancellation. There are other types of taxable income that occurs even without cash, but COD income is one of the most misunderstood tax traps. The good news is that there are exceptions and exclusions that can save you from having to write a check to the IRS.
Loans canceled as grants are not taxed. If your debt is canceled by a private lender, such as a relative or friend, and the cancellation is meant as a gift, you will have no income. While this is not income for you, if the lender waives more than $ 15,000 per year (the annual gift tax exclusion) it can be deducted from their own exemption. lifetime gift and inheritance tax. So, these loans are often canceled bit by bit. A debt canceled by a private lender’s will upon death is also not income for you.
If your lender cancels part of your mortgage, you will need to reduce your base in the residence by the amount of debt released that does not count as income for you. Note that this special relief for canceled mortgages is not automatic; to take advantage of it, you must declare the IRS Form 982, Reduction of Tax Attributes Due to Discharge.
Bankruptcy discharges are not taxable. If your debt is discharged when you are bankrupt under a court approved bankruptcy plan, it is not income for you. The amount of debt paid is used to reduce certain tax attributes, such as net operating losses or the property base. The rules are complicated and Form 982 is required.
If you are insolvent, you get a pass. Even if you are not bankrupt, if you are insolvent when your debt is paid, there is no tax. Insolvency is a simple test that means your liabilities exceed your assets. To avoid tax, your liabilities must exceed your assets by After than the amount of the debt paid. Suppose you have $ 1,000 in assets and $ 2,000 in liabilities, so you are underwater to the tune of $ 1,000. If your bank forgives a debt of $ 500, it’s not income because the forgiven amount is less than your insolvency amount.
Some forgiven student loans are not income. Another exception protects the cancellation of some student loans, but the rules are complex and constantly changing, so be careful. The student or former student escapes the tax blow if the loan is canceled under certain conditions. For useful summaries, see IRS issues tax guidelines on canceled student loans or Is the student loan forgiveness taxable? it depends.
You must take into account form 1099-Cs. No one likes IRS 1099 forms, which come in many varieties. But among the most feared 1099 forms is Form 1099-C, Debt Cancellation (PDF) indicating the amount of debt cancellation and the date of cancellation. If you receive a Form 1099-C, you usually have to pay taxes. If you think that the canceled debt is not income for you because you are insolvent or for any other reason, then don’t ignore 1099-C. Instead, complete Form 982 explaining why it is not taxable.
A price adjustment is not income. There is no income if an individual buys a property and the seller later reduces the price of the property. The buyer’s base in the property, however, is reduced by the amount of the adjustment. Nowadays, this exception can be particularly important. Suppose you bought a rental unit five years ago for $ 500,000 from the bank and you still owe them $ 400,000. The unit is only worth $ 350,000. The bank agrees to reduce the debt by $ 50,000. If this is just a debt discharge, it is COD income. But if it’s written as an adjustment to the purchase price, it isn’t.
Certain agricultural and commercial property debts receive special treatment. Even if you are solvent, there are special rules for certain qualifying farm debts. These rules only apply after you have already applied the insolvency and bankruptcy rules. Likewise, a discharge of debt incurred to acquire or build certain property used in a trade or business (qualifying commercial real estate debt) will not trigger income (subject to limits). In either case, the amount of forgiven debt excluded from gross income reduces your wealth base. See Publication 4681, Canceled debts, foreclosures, repossessions and waivers (for individuals) (PDF) for detailed information on canceled debt and reporting gains or losses resulting from repossession, foreclosure or abandonment of property. The bottom line is that COD income has always been a confusing and complicated issue. But with the special exceptions that Congress has made, it is even truer.