This is a great question to ask. Normally, debts that are forgiven are taxable income to you. For example, if you had 100k in debt and your creditors all said- forget about it and wiped it out that is fantastic, except, you now will have to pay taxes on the 100k. Why? Anytime an entity writes off a loss on their taxes it is income to someone else. Make sense? Now, let’s be clear, paying taxes on 100k is better than paying 100k. If your tax bill is 35k you just saved 65k.
Now, think of the plight of a Chapter 7 debtor who is broke and has to wipe out 100k in debt. If you then handed debtor a tax bill for 35k that would just be cruel. That would defeat the purpose of filing a Chapter 7 Bankruptcy, which is to get a “fresh start”.
So, under the IRS definitions of income- there is an exception for debts that were forgiven as a result of a Title 11 bankruptcy- which Chapter 7 falls under. A debtor who files a Chapter 7 bankruptcy and receives a discharge in bankruptcy, has just wiped out 100k. But, that debt forgiven is not taxable to debtor. IRS form 982 is the form debtors need to fill out and file with the IRS. Form 982 lets the IRS know that the debt was forgiven in a Chapter 7 Bankruptcy, and therefore, is not taxable income to debtor. If you fail to file this form with the IRS, your creditors will file a form 1099 and the IRS will want you to amend your return and report this income. File the form!
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