The recent economic recession that was observed in economies all over the world, saw the emergence of many weird and uncommon situations in the courts of law. All the courts of law and central banks had to find solutions to some very uncommon conditions that had never been seen before. Some unique cases involved a combination of taxation and debt forgiveness. However, before we proceed to tax and debt forgiveness cases, let us first try to understand the meaning of both these terms.
- Tax: Taxation is a particular fee that is levied by the government of a particular nation upon its citizens. There are various types of taxes. In the following cases, we shall be dealing with income tax, as it is more concentrated around the consumers and companies.
- Debt Forgiveness: There are many cases where some amount due that was not paid by the borrower to the lender has been relieved, that is the lender would no longer demand installments and would write off the loan as a discharged arrear. This is usually done in course of debt settlement or negotiation. In some cases, it is also done on humanitarian grounds, in order to save a particular borrower from bankruptcy. In some cases, the loan is also 'frozen', till the borrower's financial condition improves.
The question of tax, debt forgiveness, and laws relating to thereof, revolves around tax laws and the 2007 to 2009 recession cycle.
Tax and Debt Relief
The income tax structures and general laws are extremely complex, and there is persistent confusion over what to and what not to tax. Mortgage forgiveness, debt relief, and debt forgiveness are involved in the current debate that is going on, regarding the laws of taxation. Debt forgiveness, for example, in many regions across the United States, is taxed. Here's the explanation.
The installments that a borrower pays to return the debt, is considered as a financial obligation by the income tax department and, is hence, not included in the taxation bracket. Forgiveness of debt is considered as a financial favor or an income, and the amount due that is forgiven by the lender is a valid resource of income tax.
It must be noted that structure of tax is also governed by local laws. Debt forgiveness is always bound to be a point of debate, in many taxation cases. The enactments such as Mortgage Debt Relief Act of 2007, have specified some cases, where exemption is held valid.
Tax Exemptions for Debt Forgiveness
As mentioned above, government agencies are authorized to exempt individuals from specific domains of tax and forgiveness of debt is a valid ground for taxation and also for exemption, only in the following cases.
- Qualified principal residence indebtedness, is an exemption to the phenomenon of debt relief taxation, that has been created by Mortgage Debt Relief Act of 2007. This enactment applies to most of the homeowners and some commercial real estate owners.
- Another valid ground for non taxation of debt forgiveness is bankruptcy. Filing for bankruptcy relieves and clears off all arrears. These arrears are however not taxable.
- In cases where the total net worth of your assets is very less than the amount of related arrears, then it is considered as an insolvency and bankruptcy. Debt relief in such cases is not taxed.
- Some of the farm loans and debts that were incurred and forgiven, are valid for exemption. Debt relief, should be for the loan that was borrowed for farm related operations.
- Non-recourse loan is also a valid argument for exemption. However, relief of non-recourse loans have resulted into other types of tax liabilities.
To know more about debt forgiveness, you may refer to government websites and law books.