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Drawbacks to declaring oneself insolvent?

post #1 of 7
Thread Starter 

Does anyone have experience with this?  In 2010 I settled a bunch of credit card debt - and it feels amazing to be debt-free!  We stopped using credit cards about 1.5 years before settling (most of the debt was incurred trying to keep our businesses afloat).


I filed taxes and we were due to get a nice refund - money we would use to catch up with our rent.  Then the 1099-c forms came - i'd totally forgotten the forgiven debt was to be counted as income.  It was going to take away $4500 of our refund (which we'd already gotten, btw.)


so i filled out an amended form, but havent sent it yet.


we were definitely insolvent (our debts were greater than our assets) at the time the debt was settled.  If i file insolvency, we can keep the whole refund.  but i am worried that would leave us open for an audit?  i feel like the irs would have a hard time believing we only have about 12,000 in assets - a small IRA my dad help me set up a decade ago, 2 computers, wedding bands, and a home full of thrifted clothes and furniture.


are there any other drawbacks?


my credit is already damaged because of the settlement - i plan to rebuild that slowly (i actually still have a credit score that falls in the "average" range, because my credit was so good before all this).


any thoughts/experience would be great to hear.

post #2 of 7

Your liabilities were greater than your current assets? You included the current market value of all your assets, and that amount is still larger than the amount you had written off by your creditors? If so, then yes you could file insolvency. As for how it would impact you in the future? You might be auditted, but if you have nothing to hide, then that shouldn't be an issue,

I can't imagine how else it would impact you, it's a matter between you and the IRS, for one calendar year.


I do not think the IRS would have a hard time beliving you only have the above assets to your name, it's pretty average.



post #3 of 7

Well... I would make sure that if you file for insolvency that you have your ducks in a row, so to speak.  So, make a list of all your valuables (like you have above) and then assign a fair market value to them using real data.  It can be from the internet or whatever, but just something to show that you actually did the research and found what similar items were selling for.  Then, list your liabilities and determine by what amount you were insolvent.  Then, after you do that show that your insolvency exceeded the settlement amount and you're good.  If it didn't exceed the settlement, then you will owe taxes on the amount it exceeded it by.


It could open you up to an audit, but by making sure you have everything well documented there is very little they can do to argue,

post #4 of 7
Thread Starter 

thanks - i spoke with a friend and the one asset i forgot to include was the money we had at the time that we DID pay to settle the debt - we had about $4500 (saved from our 2009 tax refund) and then i borrowed $4000 from my dad (which i still owe - so i believe the loan would be an "asset" of $4000, balanced out by the "debt" of $4000 that i still owe.


any other thoughts would be appreciated, but overall it looks like i am on the right track.  i will probably have to send a check for a few hundred dollars back to the IRS.

post #5 of 7


 I just found this info that might be helpful to you:



 When are taxpayers not liable to pay taxes on forgiven debts?

There are five situations when a taxpayer is not responsible for paying taxes on the forgiven balance:

1. When the debt was discharged through filing bankruptcy.
2. When the debtor was technically insolvent at the time of settlement. A debtor is considered insolvent when their debts exceed their assets.
3. When the debt was due to a qualified farm expense.
4. When the debt was due to certain real property business losses.
5. When the discharge of the debt was treated as a gift.

To learn whether you qualify for these circumstances, you may want to consult a licensed tax professional. 


  Number 2 was what stuck out for me since you said you were truely insolvent. You might want to look into it.

Anyone know if you get a 1099-c after a short sale on a home? THis is the info I was looking for when I found the above.       



post #6 of 7
Originally Posted by UrbanSimplicity View Post

i borrowed $4000 from my dad (which i still owe - so i believe the loan would be an "asset" of $4000, balanced out by the "debt" of $4000 that i still owe.


 This is a liability, not an asset. You just changed would you owe the money too, instead of owing it to a bank (credit card), you now owe the money to your father.

From the IRS perspective, it should be a moot issue, they don't know where you came up with this $4k, they might view it as a gift from your father, but it's not an asset.


I would suggest you consult with a tax specialist, well worth a couple hundred dollars if it will save you thousands int he long run.

post #7 of 7
Thread Starter 

thanks cheryl - that is what i came across to make me start looking into this.


denver - i think i might have to go get advice - but in the meantime, I'm trying to understand what you've said - isn't the irs going to see that i was able to pay roughly $8000 (so, assset) - 4000 i had, 4000 from my dad.  i think i need to put the $4000 i borrowed on both sides of the equation - both an asset, and a liability, there by canceling it out, correct?


thanks everyone!

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