Dealing with debt cancellation can be confusing for business owners when it comes to taxes. As your accountant, I want to provide some advice on how cancelled debts impact your business taxes, as well as your options.
When a debt is cancelled or forgiven, this essentially means you no longer legally have to pay back the debt. This commonly happens when you settle a debt for less than the full amount owed. However, even though you don’t have to repay the cancelled debt, there can still be tax consequences.1
If you are a business that has debt cancelled, the cancelled amount is generally considered taxable income by the IRS.2 So if you have $10,000 in business debt forgiven, you would have to claim that $10,000 as income on your business tax return.
There are some exceptions where cancelled debt is not taxed:
But in most common situations, cancelled business debt will be taxable.
When a lender cancels or forgives a debt of $600 or more, they are usually required to send you a 1099-C form.3 This details the amount of debt cancelled so both you and the IRS are aware of the taxable income.
So if you settled a business credit card debt for less than you owed, you would likely receive a 1099-C showing the amount of debt forgiven.
As a business, the cancelled debt amount is subject to your ordinary business income tax rate. Whether you are a sole proprietor, partnership, corporation, etc., the income is taxed at your marginal rate.4This means if you are in the 22% tax bracket, $10,000 of cancelled business debt would create $2,200 of federal income taxes owed (10,000 x 22%). Plus you may owe additional state taxes on the cancelled debt as well.
When negotiating a debt settlement on a business obligation, you may be able to convince the lender not to issue a 1099-C. This requires getting written confirmation from them stating they will not report the cancelled debt or file any forms with the IRS.5If you can successfully negotiate no 1099-C, then you do not have to claim the cancelled debt. However, if audited, the IRS may still determine the debt cancellation was taxable income. So this approach does involve some risk of additional taxes/penalties down the road if not reported. Consult with your accountant on the risks and benefits of this strategy before implementing.
As mentioned before, there are exceptions where cancelled debt does not create taxable income. Two common business examples include:
Bankruptcy: Debt discharged through a Chapter 7 or Chapter 11 bankruptcy case does not create taxable income for a business.6 However, there are still many downsides with using bankruptcy, so discuss with both a lawyer and accountant before pursuing this option.
Insolvency: If your business liabilities exceed your total assets, then cancelled debt may be excluded based on insolvency rules.7 This involves filing detailed forms demonstrating insolvency with your tax returns.
These exceptions can eliminate taxes on cancelled debt, but still have negative consequences overall. Meet with your accountant to review if they truly make sense for your situation.
If you do end up with taxable income from cancelled business debts, you have a few options on how to pay:
I can help you review the cancelled debt tax implications for your business and discuss setting up an IRS payment plan if needed. Reach out to review your options.
I hope this overview gives you a better understanding of how cancelled debts affect your business taxes.
Please fill out the form below to receive a free consultation, we will respond to
your inquiry within 24-hours guaranteed.