Learn what you need to know about forgiven debt and taxes and find out which types of forgiven debt are taxable and how the Mortgage Forgiveness Debt Relief Act provides tax relief.
Money Girl
193 MG Forgiven Debt and Taxes
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Contact us before canceling entire account to continue bill credits to credit, stop and bounce and report finance agreements do. Hi, everyone. And welcome back to MoneyGirl's Quick and Dirty Tips for a richer life. I'm Laura Adams. Before we get started, there's a brand new podcast coming out this week. The girlfriend MDs quick and dirty tips to understand your body. Join Dr. Sunaz Magge and Dr. Lisa Rankin each week as they demystify medical jargon and tell women what they really need to know to stay healthy and strong. I hope you'll check out this new show. If you've had a tough time paying a debt, like a mortgage or a credit card, you may have wondered what would happen if all or a portion of it was settled or forgiven. If a creditor lowers or completely cancels a debt that you owe, does that amount of money just vanish into thin air? In this podcast, we'll cover what happens if a debt is forgiven and when you have to pay tax on it. Here's an example of a canceled debt. Let's say you have a $15,000 credit card balance and stop making payments because you lose your job. You call the credit card company and negotiate with them to reduce your total debt to $9,000 on the condition that you pay $4,500 this month and $4,500 next month. If they settle with you by accepting a total of $9,000 on a $15,000 debt, they cancel the difference or $6,000. But that's not the end of the story because the amount that gets canceled gets added to your taxable income. If your average tax rate is 25%, you'll have to shell out $1,500 on that amount of forgiven debt. So though you originally were saving $6,000, you're really only saving $4,500 after taxes, which is still significant. But can be a really rude awakening at tax time. At the end of the show, I'll give you some quick and dirty tips to help you prepare for a big tax bill so you aren't caught by surprise. There are some situations when a forgiven or canceled debt is not taxable, such as bankruptcy, insolvency for a qualified student loan or for a qualified mortgage. Here's a little more information. Bankruptcy is a legal action that helps individuals and businesses get a fresh start when they can no longer pay their creditors. Debt's discharge through bankruptcy are not considered taxable income. Solvency is when the total of all your debts is more than the fair market value of all your assets prior to the debt cancellation. A qualified student loan is a loan that includes certain obligations, such as working in a certain profession or in an underserved geographic area for a period of time in exchange for tax-free loan cancellation. A qualified mortgage is a debt secured by your main home that's used to buy, build, or substantially improve the property. This isn't a complete list of non-taxable forgiven debt, so be sure to refer to IRS publication 4681 for more information. You'll find links to everything that I mentioned in the show each week. On the blog at moneygirl.quickanddirtytips.com Cancelled mortgage debt is excluded from tax due to legislation that was passed in 2007 and 2008. The Mortgage Forgiveness Debt Relief Act applies to mortgage debt that's forgiven from 2007 through 2012 only, and it provides welcome tax relief to struggling homeowners. You can generally exclude up to $2 million of debt that's canceled due to a mortgage modification or even due to a foreclosure. As I mentioned, the debt must have been used to buy, build, or to substantially remodel your main home. After investing billions to light up our network, T-Mobile is America's largest 5G network. Plus, right now, you can switch, keep your phone, and we'll pay it off up to $800. See how you can save on every plan versus Verizon AT&T at tmobile.com/keepandswitch. Up to four lines via virtual prepaid card, a left 15 days qualifying unlocked device credit service ported 90-plus days put device ineligible carrier and timely redemption required. Card has no cash access and expires in six months. I love learning and anything that makes learning easier. If you're a parent and your child needs some homework help, then Ixcel is a right for your family. Ixcel is an online learning program for kids covering math, language arts, science, and social studies. Ixcel has interactive practice problems for topics from pre-K to 12th grade, and everything is organized by grade and subject. As kids practice, they get positive feedback, awards, and explanations for wrong answers. Ixcel figures out what your kids need more help with and recommends more topics to practice. Their videos, lessons, sample problems, and learning games too. One subscription to Ixcel gets you all subjects and all grade levels. Membership started just $9.95 a month. It's no wonder Ixcel is used in 95 of the top 100 school districts. I think the positive feedback that Ixcel gives is really crucial when it comes to learning. So make an impact on your child's learning, get Ixcel now, and money girl listeners can get an exclusive 20% off Ixcel membership when they sign up today at ixl.com/moneygirl. This at ixl.com/moneygirl to get the most effective learning program out there at the best price. Looking for toys that'll get the biggest reactions? Yes, please. Walmart has jaw-dropping toys like for real Daisy Yoga Go. Awesome. Razor Crazy Cart Shuffle. Hot Wheels. Bluey 3-in-1 airplane playset, and more. Aren't you going to say cool? I'm saving it for the holidays. Smart. Welcome to your Walmart. Refenanced debt qualifies too as long as the money wasn't used for other purposes. Like to pay off a credit card, buy a car, or to take a vacation. Debt that's forgiven on credit cards, vehicles, or second homes does not qualify for this particular tax exclusion. However, it's possible that other tax relief provisions that I previously mentioned, like bankruptcy or insolvency, may apply to your situation. If you're not sure whether you qualify for insolvency, there's a worksheet in IRS Publication 4681 that can help you find out. If you have a canceled debt that's not taxable, you still have to report it by completing a few lines on Form 982 and attaching it to your tax return. To keep up with canceled debts, creditors have to report those in the amount of $600 or more on Form 1099C cancellation of debt. If your home was foreclosed or repossessed, you might receive Form 1099A from your lender instead. Both you and the government should receive a copy of these forms by February following the tax year that the debt was canceled. Now, let's talk about taxable canceled debt. If you get a creditor or a debt collector to cancel all or a portion of a debt that's taxable, like a credit card or a medical debt, remember that the tax man won't let you off the hook so easy. If you don't want to risk getting an IRS audit and the resulting fines and penalties, any 1099 form that you receive must be filed with your tax return. To finish up, here are four tips to help you prepare for a larger than normal tax bill that you could face due to a forgiven debt. Number one, seek advice from a tax professional. Have an experienced tax preparer or an accountant look at your entire situation and estimate your tax liability so you'll know what to expect and can plan for it. Number two, put your savings on autopilot. If you get paid by direct deposit, have a portion of each paycheck sent to a separate savings account. Don't touch that money except to pay your upcoming tax bill. Number three, adjust your withholding at work. You may want to have more federal income tax withheld from your paycheck to offset your upcoming tax liability. Use the IRS withholding calculator at irs.gov to find out if you should submit an updated form W4 to your employer. And four, double check your 1099. Greditors can pile on additional interest and administrative fees to your cancelled debt. Make sure that you agree with the amount reported on a 1099 before your taxes are due. Get more money tips, resources, and updates by liking the MoneyGirl Facebook page. Just go to facebook.com and do a search for MoneyGirl. You can also follow me on Twitter at twitter.com/laraatoms. And when you visit quickanddirtytips.com, be sure to subscribe to the MoneyGirl free email newsletter for exclusive content that isn't available on the podcast or blog. I'm glad you're listening to CHING. That's all for now, courtesy of MoneyGirl, your guide to our richer life. At Credit Union of Colorado, banking doesn't have to be like this. 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