The coronavirus pandemic weighed heavily on the global economy and left many people drowning in debt. Debt forgiveness has been a major topic suggested easing the debt burden on account of the overwhelming conditions caused by the pandemic.
Mortgage debt and student loan debt forgiveness might sound like a good idea but it is always a good idea to analyze a situation and determine the potential consequences. Someone has to bear the burden of debt forgiveness and it will likely be the taxpayer. Here is what you need to know about the implications of debt cancellation.
You will be taxed for debt cancellation
The IRS considers any forgiven debt as cancellation of debt (COD) income which is supposed to be reported through a document called Form 1040 and it is also taxable. This means you will have to make some payments either way.
Tax-free benefits
Although the forgiven debt is taxable, some exceptions might further ease your burden. Borrowers should consider the following benefits.
- Insolvency exception
You will be exempted from having to pay tax on your canceled debt if you have filed for insolvency. The latter refers to a situation where a debtor’s fair market value is less than the debt owed.
- Bankruptcy exception
Individuals that file for bankruptcy under the 11 bankruptcy act are also absorbed of any tax resulting from debt cancellation. However, you will still be required to pay the COD tax if you file for bankruptcy under Chapter 7.
- Mortgage exception
Mortgage debt is also commonly considered in matters regarding tax. It is also one of the exemptions as far as debt cancellation tax is considered. You might get some tax relief if you have a mortgage but is still not clear whether lawmakers will allow mortgage debt to be canceled next year.
- Student loan exception
Students are among the demography of debtors that benefit from debt cancellation. The government is also extending income tax charges on student loans on the condition that students will work in specific professions for some time.
There are numerous other tax exemptions on debt cancellation but the above are the most common ones that apply to many people in the U.S.