Can Bankruptcy Increase Tax Liability

I filed bankruptcy, but now my accountant says that I may owe taxes due to forgiven debt. What do I do?!

It’s tax season and every year at this time I receive lots of frantic calls from clients who tell me that their accountants have informed them that they may owe taxes due to “forgiven debt”. In other words, they are told that the debt that they no longer owe because of their bankruptcy case may result in a tax liability for them. We also get lots of clients who drop off copies of the IRS Form 1099 that they received from a creditor. They all want to know: “Will I owe taxes?!”

The answer is no. Debt discharged in bankruptcy is not forgiven or written off. It is discharged. A bankruptcy discharge is not a taxable event. The debt that was once owed but that is now extinguished will not come back to haunt you in the form of a tax liability.

If you or your accountant have questions about this issue I encourage you to review IRS Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)”. This is the form that you will use in filing your tax returns to show that your discharged debt is not taxable income. You can find the form here:

http://www.irs.gov/pub/irs-pdf/f982.pdf

So, if you’ve received your bankruptcy discharge but received a Form 1099 take a deep breath and download Form 982. You won’t owe additional taxes because of your bankruptcy case.

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