Dealing with debt cancellation can be confusing when it comes to how it impacts your business’s taxes. As your accountant, I want to provide some advice on the key things you need to know when debts are forgiven or cancelled.
Debt cancellation occurs when a creditor forgives or cancels a debt you owe without requiring repayment. This usually happens when you settle a debt for less than the full amount or when the creditor writes the debt off as uncollectible.
Some common examples include:
The cancellation of debt generally results in taxable income for tax purposes, even though you did not actually receive any cash or assets. This means you may owe taxes on the amount of debt forgiven.
There are some exceptions, such as if the cancellation occurs in a bankruptcy case or when you are insolvent (liabilities exceed assets). But in most cases, the IRS considers forgiven debts to be taxable.
So if you are relieved of having to pay back $50,000 on a business loan, you may have to claim that $50,000 as income on your tax return.
There are a few scenarios where you may be able to exclude cancelled debt from your taxable income:
So in cases of bankruptcy, insolvency, non-recourse property loans, or farm debt, talk to your accountant about whether you can take advantage of income exclusions or reductions for cancelled debt.
If you have business debt cancelled, the creditor will usually issue a Form 1099-C reporting the amount of debt forgiven. They must file this with the IRS, so don’t expect to avoid declaring the amount on your tax return.
You would then report the income from debt cancellation on your business tax return (Form 1120, 1065, etc). The cancelled debt is generally reported as ordinary income.
In some cases, you may be able to report it as capital gains instead, which has more favorable tax rates. This mainly applies to real property used in a trade or business that secured the cancelled debt.
Be sure to talk to your accountant whenever you have debt cancelled to discuss the tax implications and proper reporting method. Proper reporting is crucial to avoid penalties and additional taxes if the IRS inquires about undeclared income.
If cancelled debt is taxable to your business, here are some potential deductions and credits:
Meet with your accountant to assess what deductions or credits could reduce your tax bill related to any cancelled business debts. Proper strategic use of things like NOL carryovers and business tax credits could offset some tax impact.
Here are some proactive strategies to consider regarding business debt cancellation:
Consult your accounting advisor on planning moves to minimize negative tax consequences when debts are forgiven. Careful assessment of exclusions, deductions, and settlement options could really help manage tax liability.
Having business debt cancelled or forgiven can greatly help your cash flow but also create tax headaches. As your accountant, here are the key things I want you to be aware of:
Please reach out with any questions! As your advisor, I’m here to help you understand how debt cancellations specifically affect your tax situation. With some planning, we can make the best of debt relief opportunities while properly accounting for any tax implications.
For more information, check out these additional articles on cancelled debt and taxes:
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