How Can I Prove Insolvency To The Government?
When you owe a debtor and they have exhausted all efforts to collect on the debt they may cancel the debt. This is true also if you pay back a certain amount as a “settlement” on the debt, the remainder of the debt that is not paid will be claimed on your taxes and you will be sent a 1099-C at the end of the year. If you have had a repossession of either a vehicle or a home foreclosure you will be responsible for paying taxes on the balance after they sell the home or vehicle.
Must you claim the debt?
You are required to include these 1099-C amounts as taxable income on your tax returns. The debtor will be sending a copy of the 1099-C to the Government so they are fully aware of the dollar amount from the creditor. You will be required to pay taxes on this amount unless you can prove insolvency to the government.
What if you can’t pay?
If you owe more in debts than you own in assets you may file for insolvency with the government to avoid paying taxes on the debt cancellation. You will need to provide proof by totaling your 1099-C debts as well as all of your assets that could be sold to pay the debts (home, jewelry, car, artwork or any other valuable). From these you will make up you financial statement, deducting your total assets from your total debts. If your liabilities are larger than your assets you are considered insolvent.
What to send as proof
Your financial statement, as well as a detailed letter to the government explaining why you are insolvent should be sent along with Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness”.