When you borrow money, the lender expects to be paid back. Sometimes, when you borrow money as a business owner and can’t pay it back, you can get the lender to either forgive or restructure the loan. But did you know the amount of the forgiven loan is taxable income in the year of the forgiveness? Surprising, but true.
The IRS views the funds as income, regardless of whether or not it was forgiven. Here’s why: When a company cannot pay back a loan, the lender cancels or forgives all or part of a borrower’s debt. After the borrower is no longer required to repay the debt, the IRS considers the value of that debt as taxable income. So, if you owe $20,000 on a loan and the lender cancels $15,000 of the debt, you will be taxed as if you received $15,000 in income.
But there are instances when you may be able to reduce or even eliminate the forgiven amount on your tax bill based on the kind of debt and the circumstances.
- If the debt was canceled in bankruptcy. If you choose to file for bankruptcy, any debt cleared by the courts is not considered taxable.
- If your company is insolvent. The IRS considers corporations to be insolvent if immediately before the discharge of debt, the company’s liabilities exceed the fair market value of the company’s assets.
- If the debt includes tax-deductible interest. You don’t need to report the interest as taxable income because it would have been deductible anyway.
- If the debt is part of a Paycheck Protection Program loan. If you received a Paycheck Protection Program loan, you might be eligible for forgiveness. Debt forgiven under the CARES Act is not considered taxable income.
Debt cancellation is a complicated process that can significantly impact your taxes. There may be ways to receive tax relief, but it depends on your situation. Contact Boris Benic and Associates today to learn more about how we can help you.