IRS Form 982 – How Expats Can Reduce Their Cancelled Debt Income

IRS Form 982 Do I need to file it?

Extreme caution should be taken when presenting your tax returns for a year in which some of your debt was forgiven. In an economy where we have seen years of cancelled debt due to soaring primary residence debt, rising education costs, and record level credit card debt, it has become increasingly relevant for us to address this topic as consumers demand economic help, particularly when it comes to the potential tax trap of cancelled debt and how the Form 982 could bring about tax relief.

Whether from consumer loans, student loans, home mortgages, or any other type of debt, cancellation of debt triggers a taxable event in the US, as this cancellation of debt is considered income. Most people associate cancellation of debt with an insolvency scenario, but it is not always the case; if indeed insolvent, you simply need to provide some information to the IRS on the Form 982. But if your situation does not fall under the following categories then it will likely result in a higher tax bill.

The IRS recognizes certain scenarios where this forgiveness is not considered taxable income. You can find the detailed description and IRS guidance within IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments . Below are five scenarios where an exclusion from taxable income could be applicable by utilizing a properly reported Form 982:

• Qualified Principal Residence Indebtedness
• Bankruptcy, Chapter 11
• Insolvency
• Qualified Farm Indebtedness
• Qualified Real Property Business Indebtedness

When initially explaining this topic, it almost feels silly to mention that the IRS will look to tax you on cancelled debt. From an accounting standpoint, I can begin to see how the IRS would consider cancelled debt as income – but explaining it proves, in actuality, a lot more challenging.

Most times we can simply skip the explanation and explain that this simply triggers another form going into your tax return, Form 982 for Reduction of Tax Attributes Due to Discharge of Indebtedness. This is because the IRS does not seek to tax individuals who are truly in need of economic help. This is just my opinion given the wide scope of individuals that fall under the allowed exceptions.

If your situation does not clearly fall under one of the 5 exceptions mentioned above and explained in publication 4681, I would suggest you look at the definition of insolvency as it applies to this reduction of tax attributes. I know that unfortunately people who are really insolvent won’t need a worksheet to validate their difficult financial situation, but it may surprise some what elements do and do not get taken into account for this calculation.

While credit card debt, student loans, medical bills, utilities and all your day to day bills are included in the calculation of insolvency, you should be careful to look at the goods you have accumulated throughout the years as they will count towards this insolvency calculation. Jewelry, household goods, books, art, and any interest in a financial account are all considered assets that the IRS would have you sell to cover your debt before considering you insolvent and not assessing cancellation of debt income. This will become particularly important in consumer credit card debt cases where the taxpayer may have gone on shopping sprees.

In a tight controlled taxation scheme such as the well deployed U.S. tax system, there will be enough controls to ensure that collection does not rely on the individual’s willingness to report. Sure, the enforcement side of the tax system does like to give the freedom to report or not report to the individual taxpayer, but it seems more of a pedagogic exercise to be able to catch and scold those that do not report and make an example out of them. For the lending institutions, they are required to report any cancellation of debt and issue a Form 1099-C, a tag on your social security number that will raise enough flags to warrant human review or automatic under-reporting notices from the IRS if you decide not to report it on your tax return.

I’ve seen many cases where taxpayers do not include on their tax return the information provided on Form 1099-C, almost fighting a moral battle with the IRS and trying to make an unnecessary statement. Unnecessary given that the potential income and tax bill resulting from this cancelled debt will be eliminated using Form 982.

Taxpayers with cancelled debt scenarios should be wary of self-preparing their tax returns. While some articles on the internet do provide some useful information on how to address these challenges, it is unlikely that you can replace the education and experience a tax professional will offer in ensuring that every angle of your tax situation is considered and that your Form 982 is prepared accurately and completely. Once your overall situation is analyzed and eligibility determined, there are many other factors to be taken into consideration, such as how to apply cancelled debt to assets that will realize a gain down the road. Basis of these assets are indeed impacted by cancellation of debt calculations and your tax bill can be incorrect in the year of sale if the proper reduction of tax attributes is not calculated.

As your tax professionals, we will evaluate your loan documents and individual circumstance. Details such as whether the debt is recourse or non-recourse, and the impact on classifying it as cancellation of debt or realization or income can have a significant impact on your tax bill. In this article I’ve tried to give you an introduction to the many topics that will need to be evaluated as part of your tax preparation process. I would remind you that each situation is different, and I would be happy to provide you with a no cost case evaluation to identify particular areas of interest in your situation.

Our goal at Tax Samaritan is to provide the best counsel, advocacy and personal service for our clients. We are not only tax preparation and representation experts, but strive to become valued business partners. Tax Samaritan is committed to understanding our client’s unique needs; every tax situation is different and requires a personal approach in providing realistic and effective solutions.
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Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.

When looking for a tax professional, choose carefully.  We recommend that you hire a credentialed tax professional such as Tax Samaritan that is an Enrolled Agent (America’s Tax Experts). If you are a US taxpayer overseas, we further recommend that you seek a professional who is experienced in expat tax preparation, like Tax Samaritan (most tax professionals have limited to no experience with the unique tax issues of expat taxpayers).

Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.

Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.