Relief of Indebtedness Income and Workouts under Section 108 of the Internal Revenue Code

 Relief of Indebtedness Income and Workouts under Section 108 of the Internal Revenue Code.

Shenwick & Associates performs many workouts for clients, and one point that is often overlooked during negotiations is relief of indebtedness income. 

Section 108 of the Internal Revenue Code provides that income from discharge of indebtedness is income to the Debtor, unless otherwise provided for in that section.

 The following example illustrates the point: If a debtor owes a creditor $100,000.00 and the creditor agrees to accept $50,000.00 as payment for that debt, the debtor has been enriched by the sum of $50,000.00 and the Debtor must report $50,000 of income on its tax return.

Answers to many relief of indebtedness income questions are provided below:

1. Question: Do creditors really report relief of indebtedness income to the IRS?

Answer: Yes they do and the income is reported on IRS Form 1099-C

2. Question: Which creditors report income to the IRS? 

Answer: All banks and financial institutions do. Landlords, hospitals and trade vendors generally do not report relief of indebtedness income, although they should.

     3. Question: Is the income ordinary income or capital gain? 

Answer: Sadly, it is ordinary income.

     4.  Question: Is relief from indebtedness income recognized by the guarantor of a debt?

            Answer: The IRS generally holds that a guarantor (whether or not the primary obligor has defaulted and the guarantor has become liable for the indebtedness) does not realize relief of indebtedness income on release of a liability. IRC 108(e)(2)

5. Question: Do I have to recognize relief of indebtedness income if I file for bankruptcy?

Answer: No. See section 108(a)(1)(A) of the Internal Revenue Code. This is why many debtors elect to file for bankruptcy rather than do a workout.

6. Question: If I am insolvent (my Liabilities exceed my Assets also known as the Balance Sheet test) do I have to pick up relief of indebtedness income?

Answer: No. See section 108(a)(1)(B) of the Internal Revenue Code

7. Question: What if I am a member, partner, or shareholder of a company that defaults on an unpaid debt? 

Answer: A member, partner, or shareholder of an LLC, partnership, or S corporation (a pass-through entity) must report income unless an exception applies.

Clients or their advisors with questions regarding relief of debt income should contact Jim Shenwick, Esq.   jshenwick@gmail.com   917 363 3391

 "We held individuals and businesses with too much debt!"