If you received a Form 1099-C, Cancellation of Debt, you may be wondering whether the canceled debt must be reported as taxable income. In many cases, canceled debt is taxable. However, if you were insolvent when the debt was forgiven, you may be able to exclude some or all of that canceled debt from your income.
The IRS uses Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to claim the insolvency exclusion.
What Does It Mean to Be Insolvent?
You are considered insolvent when your total debts (liabilities) are greater than the fair market value (FMV) of all your assets immediately before the debt was canceled.
In simple terms, if you owed more than everything you owned was worth, you may qualify as insolvent.
Examples of liabilities include:
- Credit card balances
- Personal loans
- Mortgage debt
- Medical bills
- Auto loans
Examples of assets include:
- Cash and bank accounts
- Retirement accounts
- Vehicles
- Real estate
- Investments
- Personal property
For additional details about insolvency, see IRS Publication 908, Bankruptcy Tax Guide.
How Much Canceled Debt Can Be Excluded?
The insolvency exclusion is limited to the amount by which you were insolvent.
For example:
- Total debts before cancellation: $50,000
- Total asset value before cancellation: $40,000
- Insolvency amount: $10,000
If $12,000 of debt was canceled, you can generally exclude only $10,000. The remaining $2,000 may still be taxable income.
Important Exceptions
The insolvency exclusion generally does not apply to a discharge of indebtedness:
- In a Title 11 bankruptcy case, or
- For certain qualified principal residence indebtedness situations unless you elect to apply the insolvency exclusion instead.
For more information about debt discharged in bankruptcy, review the IRS guidance on discharge of indebtedness in a Title 11 case.
How to Enter Form 982 in Our Program
To complete the insolvency exclusion section:
- Go to Income.
- Select My Forms.
- Choose Less Common Income.
- Select Cancellation of Debt (Form 1099-C, Form 982).
- Select Exclusions (Form 982) and enter the required information.
Additional Resources
- IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments
- IRS Insolvency Worksheet (helps determine whether you were insolvent and by how much)
- IRS Publication 908, Bankruptcy Tax Guide
Understanding insolvency can help you avoid paying tax on canceled debt that qualifies for exclusion. If you received a Form 1099-C, be sure to review your assets and liabilities carefully before filing your return. Form 982 is the IRS form used to claim the insolvency exclusion when you qualify.