If you’re making a deal with your credit card company to reduce the balance you owe, don’t forget about the other side of that transaction. The IRS considers debt forgiveness to be income – taxable income. The bigger your credit card debt, the bigger the tax bill. Just ask Angela Bibb-Merritt.
What Happens When a Debt is Forgiven?
The unfortunate entrepreneur charged over $112,000 on her credit card to finance a business only to have it fail. With some help, she was able to negotiate a reduction of more than $10,000 in the balance she owed the credit card company. That amount was reported to her on IRS Form 1099-C and was subject to income tax.
If Bibb-Merritt’s debt had been forgiven in a bankruptcy proceeding, it wouldn’t have been taxable, but because it was forgiven as part of a private negotiation, it was. The only other way to get out of paying tax on the forgiven amount is to claim insolvency. This requires proving that your debts exceed the fair market value of your assets. Key word: proving.
According to the Tax Court, this taxpayer failed to prove insolvency:
Petitioner testified that she was insolvent in 2005 when these debts were canceled. The Court advised petitioner that consideration of whether she was insolvent required a review of her assets and liabilities at the time of the discharge. Petitioner provided some information about her debts in 2005, as described above, but she did not introduce documentary evidence or testimony sufficient to determine the fair market value of her assets.
The record does not demonstrate that petitioner was insolvent before the debt cancellation. Thus, petitioner failed to prove that she was insolvent at the time the debt was canceled.
When Dealing With the IRS, Documentation is Key
This illustrates the importance of obtaining solid professional advice any time you deal with the IRS. It’s possible Bibb-Merrit really was insolvent, but she simply didn’t know what was required to prove it. If she’d assembled the proper documentation, she might have easily proven her case and had the forgiven debt amount excluded from income.
The rules can be complex, but help is available. Sometimes the rules aren’t even that complicated, but if you don’t know what they are, you’re dead before your start. Bottom line: there’s no reason to wing it with the IRS.
Want to read the full Tax Court opinion?
See Bibb-Merritt v. Commissioner; T.C. Summ. Op. 2009-78
