
Debt Discharge
Debt discharge is the cancellation of a debt due to bankruptcy. Usually, a judge decides whether or not to discharge a debt in bankruptcy and can refuse to discharge a debt if: The debtor disobeyed court orders The debtor failed to undergo financial counseling or education The debtor must then report this as miscellaneous income on Form 1040 and is required to pay income tax on the amount of the discharged debt, since having the debt discharged is the same as getting to keep the money, making it a source of income. When a debt is discharged, the debtor is no longer liable for the debt and the lender is no longer allowed to make attempts to collect the debt. When debt is discharged through a bankruptcy court, the lender can no longer make attempts to collect the debt and the debtor is no longer responsible for paying it back.
What Is Debt Discharge?
Debt discharge is the cancellation of a debt due to bankruptcy. When a debt is discharged, the debtor is no longer liable for the debt and the lender is no longer allowed to make attempts to collect the debt. Debt discharge can result in taxable income to the debtor unless certain IRS conditions are met.
Understanding Debt Discharge
When a debt is discharged, it is the result of a bankruptcy ruling. During a Chapter 7 (for individuals) or Chapter 11 (for businesses) bankruptcy, if the debtor meets all of the conditions given by the court, they may have their debt discharged by the court. When debt is discharged through a bankruptcy court, the lender can no longer make attempts to collect the debt and the debtor is no longer responsible for paying it back.
Debt discharge often results in taxable income to the debtor unless the forgiveness is a gift or bequest, but some bankruptcy discharges can be exempt from taxes if the debtor meets IRS requirements.
There are several ways that a debtor can be forgiven a debt. The two most common are when a debt is canceled or when a debt is discharged. When a debt is canceled by an institution, the institution decides they will likely not collect the debt and the remaining amount owed is forgiven. The debtor will usually receive a Form 1099-C that shows the amount of debt forgiven. The debtor must then report this as miscellaneous income on Form 1040 and is required to pay income tax on the amount of the discharged debt, since having the debt discharged is the same as getting to keep the money, making it a source of income.
The debtor must file Form 982 with the IRS, which can negate the taxation of the discharged debt if certain conditions are met. The institution can receive a bad debt write-off for the amount of the debt uncollected, which gives them a break on their taxes.
Not all debts can be discharged in bankruptcy including alimony, federal student loans, child support, tax liabilities, homeowners association dues, and personal injury judgments.
Special Considerations
Usually, a judge decides whether or not to discharge a debt in bankruptcy and can refuse to discharge a debt if:
In addition, not all debtors qualify for Chapter 7 bankruptcy. Those who are earning a high monthly wage or who have large amounts of consumer debt may be required to file Chapter 13 bankruptcy, in which debts are not discharged, but are restructured so that the debtor can regain control of his or her finances and pay off the debts. In this way, the law sets up barriers to keep consumers from racking up debt and then filing bankruptcy to avoid paying it off.
Related terms:
Form 1040: U.S. Individual Tax Return
Form 1040 is the standard U.S. individual tax return form that taxpayers use to file their annual income tax returns with the IRS. read more
341 Meeting
“341 meeting” refers to a meeting between creditors and debtors that is required to take place during the course of a Chapter 7 bankruptcy proceeding. read more
Absolute Priority
Absolute priority is a rule that stipulates the order of payment in the event of liquidation among creditors and shareholders. read more
Bankruptcy Court
Bankruptcy court is a specific kind of federal court that deals with bankruptcy. read more
Bankruptcy Trustee
A bankruptcy trustee is a person appointed by the United States Trustee to represent the debtor's estate during a bankruptcy proceeding. read more
Bankruptcy
Bankruptcy is a legal proceeding for people or businesses that are unable to repay their outstanding debts. read more
Bankruptcy Financing
Bankruptcy financing is financing arranged by a company while under the chapter 11 bankruptcy process. read more
Bankruptcy Risk
Bankruptcy risk refers to the likelihood that a company will be unable to meet its debt obligations. read more
Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)
BAPCPA was passed by Congress and signed into law by President George W. Bush as a move to reform the bankruptcy system. read more