It’s hard enough to be disabled, but even worse when the IRS slaps a steep bill on you. A 66 year old man, whose wife became ill and during that time he lost his job. Two months later his wife died. While still grieving, he discovers that he has kidney cancer and his tumor is inoperable. The disease causes other problems including pulmonary embolism and heart rhythm disorder.
This happened in 2009, in the middle of the financial downturn making it difficult for the man to find work. Bills started to pile up and he finally had to file for bankruptcy. Unfortunately, he was still stuck with over $150,000 in Parent Plus Loans that he’d taken out for his three children.
His loan servicer suggested he apply for a disability discharge to cancel out the debts. He applied and was eligible and his Parent Plus Loan debt was reduced to zero.
He felt like a weight had been lifted until he received a 1099 tax form from the IRS. They claimed that the loan amount had to be treated as income. The man calculated it was going to cost him $59,000 in taxes.
Of course, the man was bewildered. He couldn’t work, so how could he pay off the $59,000?
Kevin Thompson, CPA of Thompson CPA in Santa Monica says “a significant number of disabled people have been able to have their debts discharged and that number is growing, but under the current tax rules, the amount of that debt is taxable and that leaves many disabled borrowers unable to pay their tax bills.”
In essence, the government gives with one hand and takes it back with the other. Even though the tax debt is much less than the original debt, it’s still impossible for many disabled people to deal with.
Thompson added “an even larger looming issue is that because this amount, now considered income, has been added to adjusted gross income, some disabled people may lose public benefits that they sorely need.”
In some instances canceled debts are not taxable, including debts canceled in bankruptcy. Student loans may not be taxable if the borrower worked for a certain time in specific professions.
If a borrower can prove insolvency, meaning that their total liabilities exceed the value of their assets, they could possibly lessen or eliminate their tax burden. This might happen if a borrowers debts exceed assets by $25,000 but a $50,000 loan is forgiven. Tax would still be owed on $25,000. Insolvency still doesn’t protect borrowers who are in a vulnerable position.
Canceled debts must be treated as income in order to prevent people from using this as a loophole to get out of paying what they owe. Unfortunately, this affects people like the disabled or others who are equally vulnerable.
Not paying is a serious offense. The IRS may garnish wages, bank accounts, and property such as autos or IRA’s. They can also garnish Social Security and pension benefits. The IRS can file a tax lien and add penalties to the bill.
The IRS sends a bill and that starts the collection process. Once a borrower receives a “final notice” they have 30 days to comply and pay the bill. The letter also contains a right to appeal. If an individual files an appeal, this will stop the collection process.
A person in this situation can also request a monthly payment plan or they can file form 9465 to request a settlement amount. This is called an “offer in compromise (OIC).” Thompson states “the OIC is a daunting and time consuming process that should not be undertaken without the guidance of an expert in this arena.”
Another tactic would be to attempt to prove that monthly income is being consumed by necessary living expenses. This causes the IRS to deem the debt “currently not collectible.” It’s like putting a hold button on paying the debt.
Organizations such as the National Council of Higher Education Resources, representing student loan servicers and other organizations has brought the tax issue to Congress but they have not made much progress yet.
It’s recommended that people in this position, seek the advice of a professional tax adviser Such as Kevin Thompson, CPA. The IRS free tax preparation service for low and moderate income people is not in the position to handle more than just basic accounting services.
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