Bankruptcy Discharge

If you receive a bankruptcy discharge, the prime benefit is that you do not have to pay your debts. However, there is an added tax benefit of which many debtors are not even aware. The amount of the debt that you discharge in bankruptcy is specifically excluded from your gross income when you file your taxes. In other words, discharged debt is not taxable.

Form 1099-C

Form 1099-C is a form creditors use to inform debtors and the IRS of the amount of a cancelled or forgiven debt. While bankruptcy generally stops creditors from sending out this form, in some cases a creditor may send you a 1099-C that indicates the debt was discharged rather than forgiven. Box 6 of the 1099-C has a space where a creditor can check a box indicating bankruptcy as the cause of your cancelled debt. In this instance, the IRS should not regard your debt as taxable.

Form 982

Some creditors may send you a 1099-C without the box marked "bankruptcy" checked, even if your debt with them was included in your discharged bankruptcy. In this case, you must file Form 982 with the IRS to indicate that your debt is not taxable. Line 1a of Form 982 allows you to exclude the amount of the discharged debt by indicating that the amount represents indebtedness in a title 11 case. Title 11 simply refers to the section of the U.S. Code that describes bankruptcy, so you can include the amount here regardless of which chapter of bankruptcy you filed.

Cancelled Debt

Do not confuse discharged debt with cancelled or forgiven debt. This is an important distinction because forgiven or cancelled debt is usually taxable. For example, if you negotiate your $100,000 credit card bill to $50,000, you will owe income tax on that forgiven $50,000. If you had instead filed bankruptcy, you probably could have discharged the entire $100,000 without paying tax on any of it.