Under Internal Revenue Code (IRC) § 61(a)(11), forgiven or settled debt exceeding $600 is classified as taxable gross income unless the taxpayer qualifies for a statutory exclusion under IRC § 108.
1. Claiming the IRS Form 982 Insolvency Exclusion
- The Statutory Insolvency Test: If total liabilities exceeded total fair market value of all assets immediately prior to debt cancellation, the forgiven sum is exempt up to the insolvency amount.
- Calculating Net Insolvency: Total Debts (Mortgages, cards, loans) minus Total Assets (Bank balances, vehicles, real estate, retirement accounts).
- Filing Requirements: Attach IRS Form 982 (Reduction of Tax Attributes) to your federal tax return along with an asset/liability balance sheet ledger.
| IRS Tax Exclusion | Governing IRC Section | Qualifying Condition |
|---|---|---|
| Insolvency Exclusion | IRC § 108(a)(1)(B) | Liabilities > Assets immediately before settlement |
| Bankruptcy Exclusion | IRC § 108(a)(1)(A) | Debts discharged under Title 11 Bankruptcy (Chapter 7/13) |
| Qualified Principal Residence | IRC § 108(a)(1)(E) | Mortgage debt forgiven on primary residence |