Taxation Issues On Debt Relief
There are many different kinds of debt relief that are accessible to the individuals who struggle to pay off their financial debts. These types of persons are usually buried under mortgage debt or credit card debt. Among all the forms of debt relief that exist, many result in the restructuring of the due amount. In such a situation, both the creditor and the debtor meet and reach an agreement about the newly established general terms for the existing loan contract. Those general terms concern the length of time that it will take the borrower to fully pay off what they owe, the level of interest rates, and the frequency of reimbursement. In the majority of cases, both parties discuss about the reduction of the amount that was initially due by the borrower, in an attempt to make it easier for them to repay. All this process provokes some consequences at the taxation level for the borrower. In this article, we will discuss about the taxation issues that the debtor ends up dealing with.
Debt cancellation can be defined as a debt that has been forgiven. Forgiveness in the financial context means that the burden of the debt was removed from the shoulders of the borrower. Creditors have the possibility to forgive a percentage of the debt accumulated by debtors through the use of credit cards if the debt is old. This may also be done if for instance the creditor believes that there are a few chances that the debt be repaid in full. In addition to that, if the borrower agrees to settle at least twenty five per cent of what they owe in a lump sum, then there is the possibility that they benefit from a debt cancellation. Short sales are another well known instance of forgiveness of the debt by a creditor. When a short sale is performed, the proceeds that are collected are directed towards the lender in order to cover a mortgage debt. Nevertheless, the amount of money collected via short sales is rarely enough. In this specific situation, the creditor may decide to simply remove the remaining due amount and close the account of the borrower.
As explained in the introduction, when a borrower benefits from this kind of debt relief, they are subject to a few consequences from the point of view of the income taxation. Indeed, debt cancellation allows a debtor to release income that would have been normally owed to a creditor. In the eyes of the Internal Revenue Service, this is the same as earning income on the employment market. Consequently, the Internal Revenue Service shall apply a tax rate on the income released through the debt cancellation and oblige the borrower to settle it. In other words, in exchange for seeing their debt vanish, the debtor will have to agree to make higher future tax payments. In general, the tax rates that are effective in this type of scenario are based on the financial situation of the borrower.
Sometimes the federal government gives exceptions to this IRS taxation rule. One of those exceptions was part of the Mortgage Debt Relief Act of 2007. In an attempt to reinforce the crashed housing market, the United States federal government decided to remove all mandatory taxes from forgiven debt. Since the forgiven debt was made exempt, borrowers were obliged to have their debt apply to their primary residence that was purchased through the mortgage.
Unlike the temporary exceptions that were granted following the crisis of the housing market in 2007, there are some permanent ones that depend on the finances of the borrower. For example, in the case of a bankruptcy, the debt of an individual will be written off due to insolvency.
Debt cancellation can be defined as a debt that has been forgiven. Forgiveness in the financial context means that the burden of the debt was removed from the shoulders of the borrower. Creditors have the possibility to forgive a percentage of the debt accumulated by debtors through the use of credit cards if the debt is old. This may also be done if for instance the creditor believes that there are a few chances that the debt be repaid in full. In addition to that, if the borrower agrees to settle at least twenty five per cent of what they owe in a lump sum, then there is the possibility that they benefit from a debt cancellation. Short sales are another well known instance of forgiveness of the debt by a creditor. When a short sale is performed, the proceeds that are collected are directed towards the lender in order to cover a mortgage debt. Nevertheless, the amount of money collected via short sales is rarely enough. In this specific situation, the creditor may decide to simply remove the remaining due amount and close the account of the borrower.
As explained in the introduction, when a borrower benefits from this kind of debt relief, they are subject to a few consequences from the point of view of the income taxation. Indeed, debt cancellation allows a debtor to release income that would have been normally owed to a creditor. In the eyes of the Internal Revenue Service, this is the same as earning income on the employment market. Consequently, the Internal Revenue Service shall apply a tax rate on the income released through the debt cancellation and oblige the borrower to settle it. In other words, in exchange for seeing their debt vanish, the debtor will have to agree to make higher future tax payments. In general, the tax rates that are effective in this type of scenario are based on the financial situation of the borrower.
Sometimes the federal government gives exceptions to this IRS taxation rule. One of those exceptions was part of the Mortgage Debt Relief Act of 2007. In an attempt to reinforce the crashed housing market, the United States federal government decided to remove all mandatory taxes from forgiven debt. Since the forgiven debt was made exempt, borrowers were obliged to have their debt apply to their primary residence that was purchased through the mortgage.
Unlike the temporary exceptions that were granted following the crisis of the housing market in 2007, there are some permanent ones that depend on the finances of the borrower. For example, in the case of a bankruptcy, the debt of an individual will be written off due to insolvency.