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Unlike discharged debt, forgiven credit card debt can lead to tax liability

In late February, this blog discussed a temporary tax waiver that Congress created in the wake of the economic meltdown. That waiver applies to home mortgage issues, such as short sales, loan modifications and foreclosures, and temporarily waives tax liability on the limited issues of debt forgiveness on a home mortgage. The limited waiver is expected to expire this year.

Unfortunately the Mortgage Forgiveness Debt Relief Act, which waives the tax liability for homeowners does not apply to many other types of debt, such as forgiven or cancelled credit card debt.

As we approach the tax deadline, many Ohio residents are compiling information for their tax returns. The Great Recession made it a bumpy ride for many American consumers. And as people decided how to manage their household budget, many have considered various options. The IRS says that many American may be facing tax liability on past non-mortgage related debts that were forgiven in some form.

Tax professionals say that the IRS generally considers forgiven debt or cancelled debt as a taxable event. Forgiven debt is handled differently than debt that is discharged through a bankruptcy case.

That was part of the issue that Congress was concerned with in the big bank bailout that included the limited waiver on home mortgage tax liability related to forgiven debt. The IRS expects roughly 6.4 million American consumers this tax season will be dealing with tax liability related to forgiven or cancelled credit card debt.

Creditors send out a form called a 1099-C that involves cancelled or forgiven debts if the amount of the forgiven debt is at least $600. A consumer who receives a 1099-C may be liable for taxes on the forgiven balance, unless the consumer can prove that the debt was discharged in a bankruptcy proceeding, or that the consumer was insolvent when the debt was cancelled. Sources indicate that many 1099-Cs could contain errors. Consumers who face such issues may speak with a tax professional about the issue.

Generally, tax liabilities are not dischargeable in bankruptcy. Many households struggling with unmanageable debt rightfully consider several options when deciding what process to follow to reign in debts. It is important to fully understand the entire scope of the issues that can arise with each option.

Struggling Cincinnati area residents suffering under a mountain of debt can speak with a seasoned bankruptcy lawyer to learn when options may be available under the bankruptcy code that can provide a debtor with a fresh start.

Source: USA Today, "Canceled credit card debts come back to haunt taxpayers," Sandra Block, Mar. 4, 2012

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