When I had to do a short sale on my own house, my blood would run cold every time the mail man came to my house and I heard the thud of the letters dropping into the slot.
I knew that one day, I’d get a bill for hundreds of thousands in tax liability for “cancellation of debt” income. And then what would I do? This article spells out something you will want to know about, if you owe the IRS money or know someone who will, or are afraid you will owe them money.
IRS code sometimes protects you
It turns out that the tax code’s 7 million bazillion pages don’t just give the IRS rights. They give YOU rights too.
Some of these rights are pretty major. Sometimes, Congress really screws up. They stop worrying about just collecting the clams from Joe Taxpayer. And they give Joe a few “rights.”
Because after all, the politicians need to appease the voters back home, don’t they? One of those rights is really, really important IF you owe the IRS money and can’t pay. The weird thing is that so many folks just can’t get their arms around this. Because their accountants don’t tell them! Why don’t the accountants tell people about these important rights?
Why accountants may not tell you about your rights when you owe taxes
The accountants are often afraid of the IRS.
They don’t want to make waves. Accountants are tracked in an IRS database. And accountants worry about getting bad marks in this database. Some of them would rather play it “safe” which is not safe, but simply cowardly, when it comes to their clients.
Others don’t know about important tax code provisions that protect taxpayers. They lack the knowledge and they don’t get this knowledge when they go to the continuing education courses that they must attend. So what are these rights? I’m going to talk about two of them. One is about…
Cancellation of debt income and the dreaded 1099
If you owe money and then the debt is settled for less than you owe, the IRS code considers the amount that was forgiven or settled as “cancellation of debt income.”
You can see why this is. If you borrow $100,000, that borrowed money is not income. Borrowed money must get paid back. So no income. But if you then settle with the lender for $10,000, the $90,000 that was forgiven is suddenly money you received but do NOT have to pay back. Ever. So that $90,000 would be cancellation of debt income.
Just because you have income supposedly, does that mean you owe taxes on it? Not necessarily. There are many cases where you may get a 1099 for cancellation of debt income…and STILL owe no income tax. The tax code is very specific about three instances where you do NOT necessarily owe income tax for debts that are settled:
- If the loan was non-recourse
- If you were “technically insolvent” when the loan was settled,
- If the loan was for owner occupied real estate (with some other provisions)
There are other provisions that may mean you do NOT owe income tax on debt settlement amounts. But you get the idea.
For example, in #1 above, “non recourse”, that is the case, perhaps, if you have a first mortgage in California. First mortgages in California are usually structured as non-recourse in effect, so if you are aggressive you might do a short sale and then even if you DO get a 1099, you can show it was non-recourse because of California law.
Besides the cancellation of debt income issues, even if you do owe the IRS, there is another huge provision that can save your financial life. And again, accountants usually don’t know the ins and outs of this. Many don’t even know this exists. It’s called…
Offer-In-Compromise with the IRS
An Offer-In-Compromise sounds really good. It lets you settle with the IRS for dimes on the dollar. You just fill in a long application, perhaps speak to the IRS a few times, and voila, your debt to the IRS is mostly gone. Just cut a check and settle.
One man I know had a partner who embezzled money from their business. Payroll tax deposits went through this partner. But instead of paying the IRS, the partner took the money. And when collection notices came through the mail, the partner intercepted the mail and never showed the collection notices to anyone.
After things got pretty hot, the partner disappeared. And the other partners were left with an IRS debt of over $1 million.
So my acquaintance was one of the partners left holding the bag. It wasn’t realistic for him to ever pay the IRS the full one million dollars. So he did an OIC. The IRS accepted it, and my acquaintance cut a check for $100,000 and was given a full written release by the IRS.
Offiers-in-compromise are not granted very often. So my acquaintance was lucky. His case was an exception. The IRS grants an OIC if they feel you can never pay the money back. I had a young employee in his early twenties who got one. But that is even rarer.
So if an OIC is very diifficult to get, what else protects you if you owe the IRS money?
Currently Not Collectible status with the IRS
The IRS tax code has a provision called CNC by the insiders. Currently Not Collectible means if you owe the IRS money, and you don’t have it, you can get yourself put on CNC status.
The IRS can’t go after you.
You don’t have to worry about them.
In many cases, if they’ve pursued you and collected, they have to give the money back.
And this can go on for years, even 10 years.
CNC status is the most little-known and powerful part of the tax code. It is amazing because in many cases you can earn a pretty high income and the IRS can’t touch you.