Do You Have to Pay Taxes on Debt Discharged in Bankruptcy?

taxes on debt discharged in bankruptcy

Do You have to Pay Taxes on Debt Discharged in Bankruptcy in Arizona?

Bankruptcy is one of the most efficient ways to eliminate debt in Arizona but one important question remains. Do you have to pay taxes on debt discharged in bankruptcy? Many people ask this question because they think that debt elimination that occurs via a bankruptcy is similar to what would happen whenever a creditor discharges some debt. The processes, however, are quite different from each other.

Arizona Debt Discharge and Taxation Payments

Whenever you have some of your debt canceled, the IRS will usually view this amount as a taxable income. Thus, you will be expected to pay taxes. This rule is set up for the purpose of preventing taxation fraud.

Bankruptcies, however, are different.

The discharge of your debt via a bankruptcy in Arizona is not considered income in the same way that other kinds of debt cancellation are. You simply have to fill out a couple of documents and the IRS is not going to demand a tax payment from you. An experienced taxation attorney will give you a good idea about the procedure you need to follow in order to be freed from taxes on debt discharged in bankruptcy.

In some instances, it’s possible to get a Form 1099-C from a creditor, even when debt has been discharged in a bankruptcy. This is a form used for the purpose of reporting cancelled debt to the IRS. The form provides information about the amount of debt that has been cancelled whenever the sum exceeds 600 dollars.

If you receive a Form 1099-C after you’ve filed for bankruptcy, you will simply need to fill out Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness. By submitting this document, you’ll be free from having to pay IRS taxes on any amount that has been discharged in the bankruptcy.

What Happens to Debt Discharged Prior to the Bankruptcy?

Any debt that you have had discharged prior to your Arizona bankruptcy becoming a fact would be a completely different issue.

If a Form 1099-C has been submitted to you and the IRS before you’ve filed for bankruptcy, the respective sum would be considered taxable income. Thus, even if you file bankruptcy later on, you will still be expected to pay taxes on the respective amount.

The reason for this condition is simple – the discharged amount is no longer considered debt and as such, it’s not affected by the bankruptcy filing. The debt has now been transformed into income and your subsequent actions have no effect on it.

More Information and IRS Regulations

Many people are unaware of the manner in which bankruptcy affects their income and taxes. Luckily, a consultation with an attorney is sufficient to understand the specifics of the process and the payment of taxes after filing for bankruptcy.

Additional information about cancelled debt and tax payment is available in the IRS Publication 4681. The publication explains the specifics of getting form 1099-C from a creditor and what it would take to keep discharged debt from being counted as income in a bankruptcy.

taxes on debt discharged in bankruptcyThe most important thing to remember is that for the bankruptcy exclusion to become applicable, the respective amount of debt should have been discharged by bankruptcy court. An agreement between a debtor and a creditor doesn’t qualify as such and though it may have occurred during the bankruptcy proceedings, it may still result in taxable income.

The same rules apply for a Chapter 13 bankruptcy. Under this arrangement, debt is not discharged originally. The debtor is provided with a repayment schedule based on current disposable income. The schedule will be valid for a period ranging from three to five years. Upon the completion of the payment period, some remaining debt may be discharged and it will count as non-taxable income, as well.