Question

Your client JoJo was asset-rich but cash-poor – i.e., her assets were of the illiquid kind and couldn’t readily be sold or otherwise converted to cash. So her creditors forced her into bankruptcy court last year, where a total of $200,000 of her debts ended up being discharged.

To be clear, JoJo was never insolvent. The value of her total assets always ex-ceeded her liabilities – she just couldn’t pay her bills as they came due in the ordinary course for lack of cash.

JoJo brings you, her CPA and return preparer, the Forms 1099-C (Cancellation of Debt)*** that she – and the IRS – had received from her former creditors. Your advice as to what, if anything, to report about all of this on her tax return?

Answer 1

Background of this case: Jojo was rich but had not enough cash flows to repay her debt. So her creditors forced her to bankruptcy and she got discharged by paying an amount of $2,00,000. She had received Form 1099 C from her creditors.

Reason for getting Form 1099 C: This form is generated by a financial institutions, such as a lender after it has written off or cancelled a debt. After cancelling the debt the bank is supposed to send this form regardless of whether Jojo was discharged from debt or not. Jojo is supposed to show the discharged amount as an income in her Tax return case if the debt is not discharged.

Conclusion: In this case Jojo's debts were discharged and she is supposed to file appropriate forms with IRS to exclude the discharged debt as income from her 1040 tax return.