INCOME TAX CONSEQUENCES OF BANKRUPTCY
If you’ve been wondering whether filing bankruptcy will result in a big income tax assessment for “forgiven” debt, then you’ll be happy to learn that bankruptcy will not increase your taxes. Section 108 of the Internal Revenue Code states that when a debt is discharged in bankruptcy, the discharge doesn’t result in any additional income tax. This means that filing bankruptcy almost never has any negative tax consequences.
The misconception over bankruptcy and income taxes is due to the fact that normally, when a debt is cancelled or forgiven, income tax is owed on the amount of the debt. However, Section 108 quite sensibly prevents this from happening when you file bankruptcy.
Consumers should beware of using “debt settlement” firms which neglect to explain that income tax is owed on the amount of debt that is cancelled in such settlements, unless the consumer is insolvent at the time the debt is cancelled.
Additionally, the Mortgage Debt Forgiveness Relief Act of 2007 prevents most homeowners who go through foreclosure, or a short sale, from owing income tax on forgiven mortgage debt. This Act was recently extended by Congress through the end of the year 2016.
If you have questions about the tax aspects of debt forgiveness or discharge, call my office to set up a free consultation.