McKonomics

To Forgive Is Not Always Divine – At least as it Relates to the IRS

For tax purposes, don't think that you're off the hook if another party forgives or cancels a debt. Under the "cancellation of debt" (COD) provision in the tax law, this seemingly generous act could result in an unexpected tax bill. 

 

Basic rules: If an amount you owe is forgiven or cancelled, you must generally report it as taxable income on your personal tax return. A forgiven business debt is reported as income on the appropriate form for the business entity or sole proprietorship.

For this purpose, a "debt" includes any financial obligation for which you are legally liable or which attaches to property you own.

 

Similarly, you are required to report any interest attributable to the debt that is forgiven or cancelled.

 

However, there are several notable exceptions to the taxation of cancelled debt income, including the following seven:

Get the Latest on IRS Audit Activity

There are several ways the IRS collects money after taxpayers have payroll deductions taken, make estimated payments, and file balance due amounts with their returns.

 

Of course, the IRS can assess additional taxes after auditing the tax returns of those who arouse suspicion based on what is claimed. These examinations can take place in person or through correspondence audits, where the IRS asks taxpayers to mail in proof for particular tax return entries.

 

The IRS also randomly audits returns in order to learn more about taxpayer trends. In addition, the tax agency can file liens and levies against those who become delinquent.